1. Inventory Planning, Control and Valuation
By: Ibrahim Kuhail Ahmed Abu Lebda
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2. Introduction
Inventory may account for 50% of the total invested capital of an organization and 70% of the cost of goods sold
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3. Introduction
All organizations have some type of inventory control system
Inventory planning helps determine what goods and/or services need to be produced
Inventory planning helps determine whether the organization produces the goods or services or whether they are purchased from another organization
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4. Introduction Inventory planning and control
Controlling Inventory Levels
Forecasting Parts/Product Demand
Planning on What Inventory to Stock and How to Acquire It
Feedback Measurements to Revise Plans and Forecasts
Figure 6.1
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5. What is Inventory ? ‘A list of goods'.
A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state.
Any stored resource used to satisfy a current or future need.
An idle resource which has an economic value.
Inventory System: A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be
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6. Inventory Types Raw-materials. Work-in-progress or in-transit
Finished-goods
In the warehouse, awaiting shipment, in delivery vehicles, in tanks, on shelves, in the stores
Strategic inventory
Scrap & re-work
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7. Inventory Contents Raw Material Work in Process Finished Goods
Supplies
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8. Reasons for Inventories
Provide flexibility
minimum delay in supplying customers
a good range
Protect against uncertainties
Enable economic purchasing
Anticipate changes in demand or supply
Buffers to feed processes and enable efficient scheduling
Strategic stock holdings
Improve customer service
Transportation savings
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9. Uses of Inventory The decoupling function Storing resources
Irregular supply and demand
Quantity discounts
Avoiding stockouts and shortages
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10. Inventory Decisions
There are only two fundamental decisions in controlling inventory
How much to order
When to order
The major objective is to minimize total inventory costs
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11. Inventory costs Item cost Holding/Carrying costs Storage costs
Taxes, Insurance,
Capital costs
Risk costs
Obsolescence
Damage
Pilferage
Deterioration
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12. Inventory costs Ordering costs
Production control costs
Setup and teardown costs
Lost capacity costs
Purchase order costs
Stockout costs (Lost sales cost, Back-order cost)
Capacity-associated costs
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13. Inventory costs
Ordering costs are generally independent of order quantity
Many involve personnel time
The amount of work is the same no matter the size of the order
Carrying costs generally varies with the amount of inventory, or the order size
The labor, space, and other costs increase as the order size increases
Of course, the actual cost of items purchased varies with the quantity purchased
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14. Material-Flows Process
Production Processes
Work in
process
To Customer
Stores
warehouse
Finished
goods
WIP
From Suppliers
WIP
Inventory in transit
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15. Stock : Input (Flow in), Storage (Holding) and Flow out (Usage)
Inventory Level
Supply Rate
Stock Level
Rate of Demand (Usage)
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16. Economic Order Quantity
In trying to minimize inventory costs a company must find the order quantity which spreads the ordering or set-up costs over as many units as possible without incurring excess holding costs.
The EOQ model attempts to determine the amount of units to purchase which will minimize the total costs associated with ordering and holding inventory
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17. Economic Order Quantity
The economic order quantity (EOQ) model is one of the oldest and most commonly known inventory control techniques
It dates from 1915
It is easy to use but has a number of important assumptions
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18. How to calculate EOQ ? Tabular Approach /Trial and Error. (waste time)
Graphic Approach /By using charts.
Formula Approach /Mathematically .
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19. Graphic Approach Cost Curve of Total Cost of Carrying and Ordering
Order Quantity
Curve of Total Cost of Carrying and Ordering
Minimum Total Cost
Carrying Cost Curve
Ordering Cost Curve
Optimal Order Quantity
Figure 6.3
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20. Tabular Approach
It determines the total inventory costs at the different sizes of the order, and then the economic order or the nearest approximation by repeating the calculation a sufficient number of times
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21. Tabular Approach Example
Total demand for next year = 5000 units,
Ordering cost = $ 10 per order
Carrying Cost = $ 0.1 per unit and based on average annual inventory level
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22. Tabular Approach ExampleN Q
O = N * 10
H= Q/2*0.1
Total Cost 1
5000 10
260 2
2500 20
145 3
1667 30
113 4
1250 40
103 *5
1000 50
100 6
833 60
102 7
714 70
106 8
625 80
111 9
556 90
118
500
125
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23. EOQ Assumptions Demand is known and constant
Lead time is known and constant
Receipt of inventory is instantaneous
Purchase cost per unit is constant throughout the year
The only variable costs are the placing an order, ordering cost, and holding or storing inventory over time, holding or carrying cost, and these are constant throughout the year
Orders are placed so that stockouts or shortages are avoided completely
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24. Inventory Usage Over Time
Inventory Level
Order Quantity = Q = Maximum Inventory Level
Minimum Inventory
Figure 6.2
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25. EOQ Formula Q = number of pieces to order
EOQ= Q* = optimal number of pieces to order
D = annual demand in units
Co = ordering cost per order
Annual Ordering Cost= Number of orders placed per year x Ordering cost per order = D/Q * Co
Ch = Holding or carrying cost per unit per year
Annual Holding Cost = Average inventory x Carrying cost per unit per year = Q/2 * Ch
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26. Ordering cost = Holding cost
EOQ Formula
Ordering cost = Holding cost
(D/Q*) x Co = (Q*/2) x Ch 
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27. EOQ Example Annual demand = 12,000 units
Days/year in average daily demand = 365
Cost to place an order = $500
Holding cost /unit = $12 ( 20% Cost per unit)
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28. Sumco Pump Company Example
Company sells pump housings to other companies
Would like to reduce inventory costs by finding optimal order quantity
Annual demand = 1,000 units
Ordering cost = $10 per order
Average carrying cost per unit per year = $0.50
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29. Sumco Pump Company Example
Total annual cost = Order cost + Holding cost
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30. Sensitivity Analysis with the EOQ Model
The EOQ model assumes all values are know and fixed over time
Generally, however, the values are estimated or may change
Determining the effects of these changes is called sensitivity analysis
Because of the square root in the formula, changes in the inputs result in relatively small changes in the order quantity
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31. Sensitivity Analysis with the EOQ Model
In the Sumco example
If the ordering cost were increased four times from $10 to $40, the order quantity would only double
In general, the EOQ changes by the square root of a change to any of the inputs
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32. Restrictions on EOQ
Restrictions on order size Specified quantities of products or supplies
Restrictions on Storage Limited storage available and can not accommodate EOQ, more storage space needed and thus more cost.
Quantity discount Discount provided by the supplier  increase the needed quantity).
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33. Economic Order Quantity with Order Size Restrictions
Many companies put restrictions on the order size of the order because of the requirements of the assembly or packaging of products.
If the EOQ is not equal to one order quantities allowed, it is necessary to calculate the total inventory costs of the minimum and the maximum order size of EOQ and then compare the total cost of the minimum size and maximum allowable.
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34. Economic Order Quantity with Order Size Restrictions Example
Annual demand = 5,000 units
Cost to place an order = $10
Holding cost /unit = $0.1
The company accepts a batch of 400 units, i.e. the company can request 400 units or 800 units or 1200 units.
Required: Calculating the best alternative for EOQ
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35. Economic Order Quantity with Order Size Restrictions Example
So, the company can request either 800 units or 1200 units So the 2nd alternative is better
First Alternative ( 800 units)
Second Alternative ( 1200 units)
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36. Economic Order Quantity with Storage Limitation
Example:
Annual demand = 7500 units
Ordering cost = $75
Holding cost /unit = $0.5
Required:
Calculating EOQ
Total inventory cost
Assuming that the company has a storage capacity of 1000 units , and there is another storage that can be rented for 500 units with annual rent cost of $200. Will you advise the company to rent the storage ?
If there is another near storage with rental cost of $ 50? will you advise the company to ren?
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37. Economic Order Quantity with Storage Limitation
1. 2.
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38. 4. If the total rental cost is $50 
3. Since the storage capacity is 1000 units, the company is advised to request 1000 units each time with total inventory cost :
So, if the company request EOQ =1500 units, it will save $ 62.5, but it will pay $200 for renting $750 + $200 ( the other storage rental cost) =$950
4. If the total rental cost is $50 
Total inventory cost = $ ( rental) = 800 < 812.5
 Save $12.5
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39. Economic Order Quantity with Quantity Discount
Quantity discounts are commonly available
The basic EOQ model is adjusted by adding in the purchase or materials cost
Total cost  Material cost + Ordering cost + Holding cost
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40. Quantity Discount Models
Total cost curve for the quantity discount model
Total Cost $
Order Quantity
TC Curve for Discount 3
1,000
2,000
TC Curve for Discount 1
TC Curve for Discount 2
EOQ for Discount 2
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Figure 6.6

41. Quantity Discount Example
Annual demand is 5,000 cars, ordering cost is $49, and holding cost is 20% of the cost of the car
DISCOUNT NUMBER
DISCOUNT QUANTITY
DISCOUNT (%)
DISCOUNT COST ($) 1
0 to 999
5.00 2
1,000 to 1,999 4
4.80 3
2,000 and over 5
4.75
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42. The second step is adjust quantities below the allowable discount range The EOQ for discount 1 is allowable The EOQs for discounts 2 and 3 are outside the allowable range and have to be adjusted to the smallest quantity possible to purchase and receive the discount
Q1  700
Q2  1,000
Q3  2,000
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43. Quantity Discount Example
DISCOUNT NUMBER
UNIT PRICE (C)
ORDER QUANTITY (Q)
ANNUAL MATERIAL COST ($) = DC
ANNUAL ORDERING COST ($) = (D/Q)Co
ANNUAL CARRYING COST ($) = (Q/2)Ch
TOTAL ($) 1
$5.00
700
25,000
350.00
25,700.00 2
4.80
1,000
24,000
245.00
480.00
24,725.00 3
4.75
2,000
23,750
122.50
950.00
24,822.50
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44. Reorder Point: Determining When To Order
Once the order quantity is determined, the next decision is when to order
The time between placing an order and its receipt is called the lead time (L) or delivery time
When to order is generally expressed as a reorder point (ROP)
Demand per day
Lead time for a new order in days
ROP  
 d  L
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45. Procomp’s Computer Chip Example
Demand for the computer chip is 8,000 per year
Daily demand is 40 units
Delivery takes three working days
ROP  d  L  40 units per day  3 days
 120 units
An order is placed when the inventory reaches 120 units
The order arrives 3 days later just as the inventory is depleted
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46. EOQ and ROP example Annual Demand = 10,000 units
Days per year considered in average daily demand =365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost per unit
Lead time = 10 days
Cost per unit = $15
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47. EOQ and ROP example d = 10,000 units/year 365 days = 27.4 units/day
Reorder point = 27.4 * 10 days = 274 units
Place order for 365 units. When 274 left, place next order for 365.
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48. Order Quantities & Reorder Points
Average stock Q/2
Q =365 Q
No. of units
on hand
safety or
buffer level
274 R L L
Time
R = Reorder point
L = Lead time
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49. Order Quantities & Reorder Points
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50. Use of Safety Stock
Safety stock (SS) is extra inventory held to help prevent stockouts
If demand is unusually high during lead time, a stockout will occur if there is no safety stock
If demand or the lead time are uncertain, the exact ROP will not be known with certainty
Safety stock can be implemented by adjusting the ROP
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51. Use of Safety Stock
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52. Safety Stock and Re-order Levels
A safety stock variable is added to the equation to accommodate uncertain demand during lead time
ROP  d  L + SS
where
SS  safety stock
SS  (max Demand – Expected Demand) * d
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53. SS example
The EOQ for the Industry Co. is 600 units of and the demand is 150 units per week with lead time o two weeks, knowing that the maximum demand is 200 units. What is the ROP ?
SS  (max Demand – Expected Demand) * d
= ( 200 – 150 )* 2 = 100 units
ROP  d  L + SS
= 150* = 400units
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54. SS example Units Safety Stock weeks 0 2 Actual lead
Order
Point
400
100
Dip into safety stock 4
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55. Just-in-Time Inventory Control
To achieve greater efficiency in the production process, organizations have tried to have less in-process inventory on hand
This is known as JIT inventory
The inventory arrives just in time to be used during the manufacturing process
One technique of implementing JIT is a manual procedure called kanban
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56. Just-in-Time Inventory Control
Kanban in Japanese means “card”
Kanban systems are quite simple, but they require considerable discipline
As there is little inventory to cover variability, the schedule must be followed exactly
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57. The Kanban System P-kanban and Container C-kanban and Container
Producer Area
Storage Area
User Area 4 1 3 2
Figure 6.17
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58. Thank You
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