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Inventory Control Models and Costs

This document discusses inventory control models. It describes three types of inventories - raw materials, work-in-process, and finished goods - which help remove dependencies in the production system. It then defines important inventory terms like economic order quantity and discusses deterministic inventory models like the purchase model with instantaneous replenishment and without shortages. Examples are provided to demonstrate how to calculate the economic order quantity, number of orders per year, and time between orders.

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lalamramesh78
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12 views11 pages

Inventory Control Models and Costs

This document discusses inventory control models. It describes three types of inventories - raw materials, work-in-process, and finished goods - which help remove dependencies in the production system. It then defines important inventory terms like economic order quantity and discusses deterministic inventory models like the purchase model with instantaneous replenishment and without shortages. Examples are provided to demonstrate how to calculate the economic order quantity, number of orders per year, and time between orders.

Uploaded by

lalamramesh78
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Inventory Control

7.1 INTRODUCTION
Inventory is essential to provide flexibility in operating a system or organization. An inventory can
be classified into raw materials inventory, work-in-process inventory and finished goods inventor:
The raw material inventory removes dependency between suppliers and plants. The work-in-proces
inventory removes dependency between various machines of a product line. The finished gook
inventory removes dependency betvween plants and its customners or market. The main functions of
an inventory are: smoothing out irregularities in supply, minimizing the production cost and allYwing
Organizations to cope up with perishable materials.
Some important termenologies of inventory control arediscussed now.
Inventory decisions. The following two basic inventory decisions are generally taken by
managers.
1. When to replenish the inventory of an item?
2. How much of an item to order when the
inventory of that item is to be replenished?
Costs of inventory systems. The following costs are
associated with the inventory system.
1. Purchase price/unit
2. Ordering cost/order
3. Carrying costhunit/period
4. Shortage cost/unitperiod.
Costs trade off. If we place frequent
carrying cost will be less. On the orders, the cost of ordering will be more, but
other hand, if we place less frequent the inventoy'
be less, but the carrying cost orders, the
cost increases and the will be more. In Fig. 7.1, for an ordering cost w
ordering cost decreases. The total cost increase in 0 (order size), the carryu
cost and carrying cost for each order size. The order size at curve represents the sum of Orue
economic order quantity (EO0) or optimal which the total cost is minimum is Cal
order size (0).
7.2 MODELS OF INVENTORY
There are different models of
models and probabilistic inventory. The inventory models can be
models. into deterministic
The various
(a) Purchase model
with deterministic models are: classified
instantaneous replenishment and without
194
shortages;
Inventory Control 195

Total cost

Carrying cost
TC*

Costs

Ordering cost

Order quantity
Fig. 7.1 Trade-off between costs.

(b) Manufacturing model without shortages;


shortages;
(c) Purchase model with instantaneous replenishment and with
(d) Manufacturing model with shortages;
These models are explained in the following sections.
Replenishment and without
7.2.1 Purchase Model with Instantaneous
Shortages
inventory model, orders of equal size are placed at periodical intervals. The items against an
In this consumed at a constant rate. The purchase
Order are replenished instantaneously and the items are
price per unit is same irrespective of order size.

Let us suppose, D= Annual demand in units


Co = Ordering cost/order
Ce = Carrying costunit/year
P =Purchase price per unit
Q =0rder size
in Fig. 7.2. From the above
vOresponding purchase model can be represented as shown
assunptions, we have:
D
The number of orders/year =

Average inventory 2

Cost of ordering/'year
Operations Hesearch
196

Units à

-t 4
Time
Fig. 7.2 Purchase model without shortage.

Cost of carrying/year =
2
Purchase cost/year = DP
Therefore,
Total inventory cost/year = D + DP
Differentiating with respect to yields

do (TC)=C, +
Differentiating it again with respect to Q yields
(Tc) - 2D
Co
Since the second
derivative to zero. derivative is
Therefore, positive, optimal value for O is
the
obtained by equating the trs
C, +
Hence, the optimal order size is Or
2C,CeD
and
2C,CeD
where Total number of
orders per year = D

Time between
orders = D
nventory Control 197
Example21 Ram Industry necds 5,400 units/year of a bought-out component which w1l be used
inits main product. The ordering cost is Rs. 250 per order and the carrying cost per unt per year
Is Rs. 3O Find: the economic order quantity (EOQ), the number of orders per year and the time
etween successive ordeIs.

Solution
D =5,400 units/year
C, = Rs. 250/order
C =Rs. 30/unitlyear
Therefore, the economic order quantity

x 250 x 5,400
EOQ (2*) = 30
300 units

where
D 5,400
Number of orders/year = 300
= 18
*
and
300
Time between successive orders = D 5,400
=0.0556 year
=0.6672 month
= 20 days (approx.)
be
Example 7.2 Alpha Industry needs 15,000 units per year of a bought-out component which will
unit per
used in its main product. The ordering cost is Rs. 125 per order and the carrying cost per
75. Find: economic order
year is 20% of the purchase price per unit. The purchase price per unit is Rs.
quantity, number of orders per year and time between successive orders.
Solution We have
D = 15,000 units/year
Co = Rs. 125/order
Purchase price/unit = Rs. 75
C = Rs. 75 x 0.20
= Rs. 15/unit/year
Iherefore, the economic order quantity 1S
|2 x 125 x 15,000 500 units
EOQ = 15
and

D 15,000
Number of orders/year = = 30
500
198 Operatons Research

Time between successive orders is obtained as


500
=0.033 year = 0,4 month 12 days
D 15,000

7.2.2 Manufacturing Model without Shortages


If a company manufactures an item which is required for its main product, then
the
model of inventory is called manufacturing model. In this model, shortages are not
rate of consumption of the item is assumed to be uniform throughout the year. The permitted
and consumed simultaneously for a portion of the cycle time. During the
corresponding
item is prodw
the consumption of the item takes place and the cost of remaining cycle time
production lot size. production per unit is same irrespective
Let us suppose,
r= Annual demand in units
k = Production rate of the item (total
C, = Cost per set-up
number of units produced/year)
C = Carrying
cost/unit/year
p= Cost of production/unit
t =Period of production as well as
I, = Period of consumption of the item
consumption only
t= Cycle time (i.e. t = t + t
The operation of the manufacturing model without
shortages is shown as in Fig. 7.3.

Units k-r
k

Time
Fig. 7.3
Manufacturing model without shortages.
it is
During the period t1, the item is
of k consumed
at the produced at the rate of k units per
- r units per rate ofr units per period.
period. During the During this period, the period and simultaneously
consumption of period tz, the
per period duringthethissame item is continued. Hence, the production inventory
of the item is
is built at the raie
below. time t,. The various
formula to be inventory is
decreased discontinued
at the rate of r
but the
applied for this kind of unts
situation givell
are
Economic batch quantity (EBQ or 0) = 2C,r
C.[1 - (rIk)]
Inventory Control 199

Period of production as well as consumption, ; =


k

Period of consumption only, t; = Q*[l - (rlk)] (k -r)h

J Cycle time = t +

VNumber of set-ups per ear


Ruenle 7.3 An automobile factory manufactures a particular type of gear within the factory.
This gear isused in the final assembly. The particulars of this gear are: demand rate r =14,000 units/
roduction ratek=35,000 units/year, set-up cost, Co = Rs. 500 per set-up and carrying cost,
C,= Rs. 15/unit/year.
Find the economic batch quantity (EBQ) and cycle time.
Solution Applying the required formulae, we have the economic batch quantity

-
2Cr
VC[! - (r/k)]
2 x 500 x 14,000
Vis[1 -(14,000/35,000)]
= 1,247.22 units
=1,248 (approx.)
Now, the period of production as well as consumption

1,248
35,000
=0.0357 year
=0,4284 month
= 13 days (approx.)
and the period of consumption

-)
1,248 14,000
14,000 35,000

=0.0535 year
=0,642 month
= 20 days (approx.)
Qperallons Hesearch
200

Therefore. the cycle tne is I-i+-13 +20 =33 days

Also 14,000
= |1.22
set-ups per year 1,248
The number of

7.2.3 Purchase Model withInstantaneous Replenishment and with Shotan


and it is
order will be received instantaneously consumed at a
model, an itenm on order size. If there is no
In this irrespective of stock at
purchase price per unit is same that it will be satisfied at a later date
The the item, it is assumed
recenving arequest for modelis shown as in Fig.
7.4.
backordering. The
This Is called

Units

Time
Fig. 7.4 Purchase model with shortages.

The variables which are to be used in this model are:


D= Demand/period
C,= Carrying cost/unit/period
C= Ordering cost/order
C,= Shortage cost/unit/period
Q=Order size
Q, - Maximum inventory
Q, -Maximum stock-out
Period of positive stock
,- Period of shortage
I=Cycle time (, +)
Inventory Controt 201
Optmal values of the above vanabhles are

V C C, +C

D
where

D
Number of orders/period =

Example 7.4 The annual demand for a component is 7,200 units. The carrying cost is Rs. 500 unit
year, the ordering cost is Rs. 1,500 per order and the shortage cost is Rs. 2,000 unit year. Find the
optimal values of economic order quantity, maximum inventory, maximum shortage quantity, cycle time
(), inventory period (1,) and, shortage period (,).
Solution We have
D=7,200 units/year
C, =Rs. 500/unit/year
Co Rs. 1,500/order
C,=Rs. 2,000/unit/year
Therefore,
|2,D C,+ C
Economic order quantity C

2 x 1,500 x 7,200 2,000 500


S00 2,000

- 233 units (approx.)


Operations Hesearch
202

2C,D
Maxinumn inventory Oi C, +Ce

2,000
|2 x 1,500 x 7,200
500 2,000 + 500

=186 units (approx.)

Maximum stock-out O; = Q-0 = 233 186 = 47 units


233
Cycle time = =
x 365 = 12 days (approx.)
D 7,200

186
Period of positive stock t = 7,200
x365 = 10days (approx.)
D

Period of shortage t; -i = 12 -- 10 = 2 days


D 7,200
Number of orders per year 233
30.9

7.2.4 Manufacturing Model with Shortages


In this model, an item is produced and consumed simultaneously for a portion of the cycle time
During the remaining cycle time, only the consumption of the item takes place. The cost of production
per unit is the same irrespective of the production lot size. Stock-out is permitted in this model, and
it is assumed that the stock-out units will be satisfied from the units which will be produced at a later
date, with a penalty. This is called backordering. The operation of this model is shown in Fig. 73.

Q. k-r, r
k-r

Time
Fig. 7.5
Manufacturing model with shortages.
Inventory Control 203
The variables which are used in this model are given below:

r= Demand of an
item/period
Production rate of the item (number of units
C,=Cost/set-up
produced/period)
- Carrying costunitperiod
C= Shortage costunit/period
I= Total cycle time
production/unit
p= Cost of
Period of production as well as consumption of the item satisfying period's requirement
I, = Period of consumption only
I,=Period of shortage
t.=Period of production as well as consumption of the item satisfying back order
The formulae for the optimal values of the above variables are presented below:

Economic batch quantity = 2CC kr


k -r C

C
Maximum inventory Q; = VC |2Co r(k - r)
C, + Cs

2C,Ce r(k - r)
Maximum stock out C,(C, +C;) k

k -r

=
t4 k -r
per
per year. Its production rate is 1,000 units
Example 7.5 units shortage
The demand for an item is 6,000 set-up cost is Rs. 2,000 per set-up. The
month. The carrying cost is Rs. 50/unit/year and the
parameters of the inventory
system.
Cost is Rs. 1.000 per unit per year. Find various
Operations Research
204

Solution Here
r= 6,000 units/year
k=1,000 x12 = 12,000 units/year
C,= Rs. 2,000/set-up
C= Rs. 50/unit/year
C,= Rs. 1,000/unityear
Therefore,
2C, kr
C +C
@(EBQ) =

VCe k-r C,
2 x 2,000 12,000 x 6,000 50 + 1,000
50 12,000-6,000 1,000
= 1004 units (approx).

2C,Ce r(k - r)
VC,(C, + C)
2 x 2,000 x 506,000(12,000 6,000)
V1,000(50 + 1,000) 12,000
= 24 units (approx.)

12, 000 - 6,000


x 1,004 - 24 = 478 units
12,000

Q* 1,004
X365
6,000s0 = 61 days (approx.)

X 365 = 478
k -
12,000 -6,000 x 365 = 29 days (approx.)
478
X 365 =
6.000X 365 = 29 days (approx.)
X 365 = 24
6,000 x 365 = 1.5 days (approx.)

k -r X 365 24
12,000 -6,000 x 365 = 1.5 days (approx.)

Common questions

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In inventory management, a trade-off exists between ordering cost and carrying cost. Frequent orders may increase the ordering cost but reduce the carrying cost, as less inventory is held at any time. On the contrary, infrequent orders might decrease the ordering cost but increase the carrying cost due to holding more inventory. Thus, optimizing this balance is crucial for minimizing total inventory costs .

A manufacturing model without shortages involves producing and consuming inventory simultaneously for part of the cycle time, unlike purchase models, where orders are received and restocked. This model assumes uniform consumption and shortage prevention by coordinating production and consumption. It typically focuses on in-house production needs, considering set-up and carrying costs .

Deterministic models assume fixed variables such as demand and lead time, making them suitable for environments with predictable, stable conditions. Probabilistic models account for variability and uncertainty, allowing for strategies that better handle fluctuating demand or supply. Choosing between them affects ordering frequency, safety stock levels, and the responsiveness to changes in supply chain dynamics .

Frequent ordering increases ordering costs but can lower carrying costs since less inventory is held at any time, reducing risk and capital tied in inventory. Conversely, less frequent ordering decreases ordering costs but increases carrying costs as more inventory accumulates, potentially raising storage and obsolescence costs, thereby increasing the total cost .

To calculate the economic batch quantity (EBQ) in manufacturing, use the formula: EBQ = sqrt((2 * C * r) / (C_e * (1 - (r/k)))), where C is the setup cost, r is the demand rate, k is the production rate, and C_e is the carrying cost per unit per year. Factors considered include setup costs, carrying costs, production rates, and demand rates, all influencing the balance between the cost of setting up production runs and carrying inventory .

In a purchase model with instantaneous replenishment and without shortages, orders are placed at periodical intervals, and the ordered items are replenished instantaneously. These items are consumed at a constant rate. The purchase price remains the same irrespective of order size. This model is often used when there's a stable demand and continues to minimize shortages and excess inventory .

The primary functions of an inventory are to smooth out irregularities in supply, minimize production costs, and allow organizations to cope with perishable materials .

Unlike the model without shortages, the manufacturing model with shortages allows for backordering, where unmet demands are fulfilled later. It considers a cycle with a production phase to build inventory and a consumption phase where shortages can occur. The model includes constraints on maximum stock-outs and the periodic fulfillment of shortages from subsequent production .

The Economic Order Quantity (EOQ) is the order quantity that minimizes the total holding costs and ordering costs in an inventory system. It is calculated using the formula EOQ = sqrt((2 * D * C_o) / C_e), where D is the annual demand, C_o is the ordering cost per order, and C_e is the carrying cost per unit per year .

Shortage cost impacts inventory decisions by introducing a penalty for unmet demand, incentivizing holding safety stock. It is calculated considering the cost per unit per unit of time the shortage persists. This cost is balanced against carrying and ordering costs within models to find optimal stock levels, mitigating lost sales or production delays .

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