5. Chapter 16 Inventory Management IDS 605 Busing

6. Purposes of Inventory l Meet expected demand l Absorb demand fluctuations l Protect against unexpected increases in demand l Decouple stages in the production process l Take advantage of quantity discounts l Hedge against possible price increases l Protect against disruption in delivery from suppliers Transparency 16.1

7. Types of Inventory l Raw materials l Work-in-process (WIP) l Finished goods l Replacement parts l Supplies l Transportation Transparency 16.2

8. Dependent and Independent Demand l Dependent Demand = usually generated by a company’s own production process l Independent Demand = usually from outside sources such as customers Transparency 16.3

9. Types of Inventory Systems l Perpetual (Continuous Review) »Inventory level continuously monitored »Transactions recorded as they occur »Maintain specific level of inventory l Periodic »Inventory counted only at regular intervals »Inventory depends upon demand Transparency 16.4

10. ABC Classification of Inventory Items Transparency 16.5(Exhibit 16.2) 1 2 3 4 5 6 7 8 9 10 5,000 200 2,000 800 1,000 1,200 1,300 2,500 3,500 500 $ 30 450 10 20 10 5 4 2 1 20 $ 150,000 90,000 20,000 16,000 10,000 6,000 5,200 5,000 3,500 1,000 306,700 48.91 29.34 6.52 5.22 3.26 1.96 1.69 1.63 1.14.33 AABBBCCCCCAABBBCCCCC Cumulative Annual Unit Annual Dollar % Annual % Annual Item Demand Cost Usage Dollar Usage Dollar Usage Classification 48.91 78.25 84.77 89.99 93.25 95.21 96.90 98.53 99.67 100.00

11. Aggregate Performance Measures -Average inventory investment -Turnover ratio - Days of inventory Annual cost of goods sold Average inventory investment Days per year Turnover ratio Transparency 16.6

12. Costs of Inventory l Inventory Ordering Costs »Fixed –Staffing –Office and equipment »Variable –Shipping –Order placing –Setup cost –Lost materials –Receiving and inspection l Inventory Holding Costs »Fixed –Warehouse-capital –Property taxes –Warehouse-operating –Personnel »Variable –Cost of capital –Insurance –Losses –Inventory taxes –Rental costs Transparency 16.7

13. EOQ Model Assumptions 1. Constant known demand rate 2. Cost per unit fixed 3. Instantaneous replenishment 4. Ordering and carrying cost known and independent Transparency 16.8

14. Basic EOQ Inventory Pattern Transparency 16.10(Exhibit 16.4)

15. Total Annual Variable Costs Transparency 16.9(Exhibit 16.3)

16. EOQ Model D = Annual Demand rate C o = Variable ordering cost C h = Variable holding cost Transparency 16.11

17. EOQ Model D = Annual Demand rate C o = Variable ordering cost C h = Variable holding cost D = 1,000 units/year C o = $50 per order C h = $5 per unit per year Transparency 16.11

18. Total Annual Variable Cost (Slide 1 of 2) Annual variable ordering cost = C o Annual variable holding cost = C h Total annual variable cost = C h + C o D Q Q Q Q D 2 2 Transparency 16.12a

19. Total Annual Variable Cost (Slide 2 of 2) D = 1,000 C o = $50 C h = $5 EOQ = 141.42 Total annual variable costs 141.42 1,000 2 141.42 140 1,000 2 140 145 1,000 2 145 200 1,000 2 200 EOQ: 140: 145: 200: (5) + + + + (50) = $707.11 (50) = $707.14 (50) = $707.33 (50) = $750.00 Transparency 16.12b

20. Quantity Produced During Replenishment Period vs. Maximum Inventory Transparency 16.13(Exhibit 16.7)

21. Finite Replenishment Rate Model D = annual demand rate C o = Variable ordering cost C h = variable holding cost d = dally demand rate p = daily production rate Total annual variable costs D = 1,000; C o = $50; C h = $5; d = 4; p = 10 Transparency 16.14