6/12/2014
Course outline
Economic Order Quantity.
Safety stock, Re-order point, Lead
time.
Chapter 4 ABC analysis
INVENTORY CONTROL
‘Besides gravity, nothing keeps me down.’
Industrial Engineering and Management, BME III/II
Industrial Engineering and Management, BME III/II 2
By: Khem Gyanwali, Thapathali Campus, IOE,TU
Inventory control Inventory control
Inventory is defined as the list of movable goods which Inventory control may be defined as the scientific
helps directly or indirectly in the production for sale. method of finding how much stock should be
Inventory is a service to production. It is just a sort of maintained in order to meet the production demands
investment in the form of raw materials, tools, gauges, and be able to provide right type of material at right
supplies etc. time in the right quantities and at competitive price.
Classification of inventories
1. Direct inventories
a. Raw materials.
b. In process inventories (work in progress).
c. Purchased parts.
d. Finished goods.
2. Indirect inventories
a. Tools (standard and hand tools).
b. Supplies (miscellaneous).
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
3 By: Khem Gyanwali, Thapathali Campus, IOE,TU
4
Inventory control Inventory control
Factors affecting material planning Relevant inventory costs
• Macro factors – Price trends, business cycles, Purchase cost: It is the actual price paid for procurement of
government import policy, credit policy items. Its unit of measurement is in Rs. Per unit.
• Micro factors – Corporate objectives, plant capacity Purchase cost = price per unit (Cu) x demand per unit time (S)
(and utilization), rejection rates, inventory levels, lead Where, Cu = unit cost and S = annual demand.
time etc.
Ordering cost: It is the cost of placing an order from a vendor.
This includes all costs incurred from calling for quotations to
Objectives of inventory management the point at which the item is taken into stock.
• Provide acceptable level of customer service (on-time If S = annual requirement then
delivery) Annual cost of ordering = S x Co/q
• Allow cost-efficient operations
• Minimize inventory investment
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
5 By: Khem Gyanwali, Thapathali Campus, IOE,TU
6
1
6/12/2014
Inventory control Inventory control
Holding (carrying) Costs: The costs incurred in Order quantity strategies
maintaining the stores in the firm. It includes storage
cost, cost of obsolescence, cost of deterioration and Lot-for-lot: Order exactly what is needed for the
spoilage, cost of insurance, cost of capital etc. next period
Annual carrying cost = Cu x i x q/2 Fixed-order quantity: Order a predetermined
Where, i = interest rate and q = order quantity. amount each time an order is placed
Min-max system: When on-hand inventory falls
Shortage Costs: Loss of customer goodwill, back order
handling, and lost sales below a predetermined minimum level, order
enough to refill up to maximum level
Total inventory cost = Purchase cost + Inventory carrying Order n periods: Order enough to satisfy demand
cost + Ordering cost + Shortage cost. for the next n periods
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
7 By: Khem Gyanwali, Thapathali Campus, IOE,TU
8
1. Economic Order Quantity 1. Economic Order Quantity
Three Mathematical Models for Determining Order Economic Order Quantity
Quantity It is the order quantity which will minimize the total variable cost
of managing the inventory.
• Economic Order Quantity (EOQ or Q System) In determining ‘Economic Order Quantity’ it is assumed that the
– An optimizing method used for determining order quantity cost of managing the inventory costs of two parts i.e.
and reorder points Total annual costs = annual ordering costs + annual holding costs
– Part of continuous review system which tracks on-hand
inventory each time a withdrawal is made EOQ Assumptions:
• Economic Production Quantity (EPQ) – Demand is known & constant - no safety stock is required
– Lead time is known & constant
– A model that allows for incremental product delivery – No quantity discounts are available
• Quantity Discount Model – Ordering (or setup) costs are constant
– All demand is satisfied (no shortages)
– Modifies the EOQ process to consider cases where – The order quantity arrives in a single shipment
quantity discounts are available
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
9 By: Khem Gyanwali, Thapathali Campus, IOE,TU
10
1. Economic Order Quantity 1. Economic Order Quantity
Determining Inventory Level
Maximum Level
Economic Order Quantity
(EOQ)
2×𝐶𝑜×𝑆
Average Inventory =√
𝐶𝑢×𝑖
Inventory Level
Total variable cost of managing
Reorder Level the inventory per year,
𝑆
E = 𝐶𝑜 × + 𝐶𝑢 × 𝑖 × 𝑞/2
𝑞
Cycle Time Lead
Time Period Time
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
11 By: Khem Gyanwali, Thapathali Campus, IOE,TU
12
2
6/12/2014
1. Economic Order Quantity 2. Safety stock, Re-order point, Lead time
A company requires 16000 units of raw material costing Rs. 2 per unit.
The cost of placing an order is Rs. 45 and the carrying costs are 100% per
year per unit of the average inventory. Determine:
i. The economic order of quantity
ii. Cycle time
iii. Total variable cost of managing the inventory.
Solution:
Now, S = 16000, C0 = Rs. 45, Cu = Rs. 2, i = 0.1
2×𝐶𝑜×𝑆 2×45×16000
i) EOQ = √ =√ = 2684 units.
𝐶𝑢×𝑖 2×0.1
ii) Cycle time = 1/(No. of orders/year) = 1/(16000/2684) year = 2
months
iii) Total variable cost of managing the inventory
(E) = Co.S/qo + [Link]/2 = 45*6 + (2*0.1*2684)/2 = RS. 538.4
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
13 By: Khem Gyanwali, Thapathali Campus, IOE,TU
14
2. Safety stock, Re-order point, Lead time 3. ABC analysis
Safety stock
It is also known as Always Better Control
It refers to the items of inventory kept in stock as an insurance stock to It divides inventories into three groupings in terms of
meet the fluctuations in demand or lead time. percentage of number of items and percentage of total
value.
Lead time A – items: constitutes about 10 % of the total number
The time between placement of the requisition of an item and its of items and 70 % of the total money value for all
receipt for actual use is called delivery lag or lead time.
items.
Re-order point B – items: constitutes about 20 % of the total number
It is pre-known that it takes days between initiating the order and of items and 20 % of the total money value for all
receiving the required quantity. Re-order point indicates that at this items.
time the purchase order should be initiated and if not done so, the
inventory may exhaust and even the reserve stock utilized before the C – items: constitutes about 70 % of the total number
new material arrives. It may result in stoppage of production. of items and 10 % of the total money value for all
items.
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
15 By: Khem Gyanwali, Thapathali Campus, IOE,TU
16
3. ABC analysis 3. ABC analysis
Value Objectives of ABC analysis
A
(A) • It enables selective control
Percentage of Value
Items
10 % 70 %
• The degree of control related to materials
20% (B) 20 %
B Items planning, forecasting, ordering, review,
70 % (C) 10 % records, postings, revisions, lead time analysis,
C Items safety stock etc. is rigorous A items, moderate
for B items and minimum for C items.
Number
• It is helpful to rationalize the number of
Percentage of Numbers orders and reduce the overall inventory.
Industrial Engineering and Management, BME III/II Industrial Engineering and Management, BME III/II
By: Khem Gyanwali, Thapathali Campus, IOE,TU
17 By: Khem Gyanwali, Thapathali Campus, IOE,TU
18
3
6/12/2014
3. ABC analysis
Control policies for A Control policies for B Control policies for B
items items items
• Should be ordered • General in between • The safety stock
more often, but in those for A and C. should be liberal
small quantities to • Order for these items (requirement of 3
reduce capital locked must be placed less months or more).
up. frequently. • Annual or six-
• Future requirement • The safety stock monthly orders
must be planned. should be medium (3 should be placed to
• Purchases and stock months or less). reduce paper work
should be looked by and ordering cost
• B items are subjected and to get advantage
top executives. to moderate control of quantity discount
• Ordering quantities, for large orders.
re-order point and
maximum stock • In case of these
should be revised items only routine
more frequently. check is required.
Industrial Engineering and Management, BME III/II
19 Industrial Engineering and Management, BME III/II 20
By: Khem Gyanwali, Thapathali Campus, IOE,TU