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Lecture4

Inventory ManagementChapter 11

2

Independent Demand

A

B(4) C(2)

D(2) E(1) D(3) F(2)

Dependent Demand

Independent demand is uncertain. Dependent demand is certain.

Inventory: a stock or store of goods

Dependent and Independent DemandDependent and Independent Demand

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Types of InventoriesTypes of Inventories

Raw materials & purchased parts

Partially completed goods called work in progress

Finished-goods inventories (manufacturing firms)

or merchandise (retail stores)

Replacement parts, tools, & supplies

Goods-in-transit to warehouses or customers

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Functions of InventoryFunctions of Inventory

To meet anticipated demand

To smooth production requirements

To decouple operations

To protect against stock-outs

To take advantage of order cycles

To help hedge against price increases

To permit operations

To take advantage of quantity discounts

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Objective of Inventory ControlObjective of Inventory Control

To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds

Level of customer service

Costs of ordering and carrying inventory

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A system to keep track of inventory

A reliable forecast of demand

Knowledge of lead times

Reasonable estimates of Holding costs

Ordering costs

Shortage costs

A classification system

Effective Inventory ManagementEffective Inventory Management

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Inventory Counting SystemsInventory Counting Systems

Periodic SystemPhysical count of items made at periodic intervals

Perpetual Inventory System System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

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Inventory Counting Systems (Cont’d)Inventory Counting Systems (Cont’d)

Two-Bin System - Two containers of inventory; reorder when the first is empty

Universal Bar Code - Bar code printed on a label that hasinformation about the item to which it is attached

0

214800 232087768

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Lead time: time interval between ordering and receiving the order

Holding (carrying) costs: cost to carry an item in inventory for a length of time, usually a year

Ordering costs: costs of ordering and receiving inventory

Shortage costs: costs when demand exceeds supply

Key Inventory TermsKey Inventory Terms

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ABC Classification SystemABC Classification System

Classifying inventory according to some measure of importance and allocating control efforts accordingly.

AA - very important

BB - mod. important

CC - least important

Figure 11.1

Annual $ value of items

AA

BB

CC

High

Low

Few ManyNumber of Items

11

Economic order quantity (EOQ) model

Economic production model (EPQ)

Quantity discount model

Economic Order Quantity ModelsEconomic Order Quantity Models

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The Inventory CycleThe Inventory CycleFigure 11.2

Profile of Inventory Level Over Time

Quantityon hand

Q

Receive order

Placeorder

Receive order

Placeorder

Receive order

Lead time

Reorderpoint

Usage rate

Time

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Total CostTotal Cost

Annualcarryingcost

Annualorderingcost

Total cost = +

Q2H D

QSTC = +

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Cost Minimization GoalCost Minimization Goal

Order Quantity (Q)

The Total-Cost Curve is U-Shaped

Ordering Costs

QO

An

nu

al C

os

t

(optimal order quantity)

TCQ

HD

QS

2

Figure 11.4C

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Deriving the EOQ & Minimum Total Deriving the EOQ & Minimum Total CostCost

The total cost curve reaches its minimum where the carrying and ordering costs are equal.

Q = 2DS

H =

2(Annual Demand)(Order or Setup Cost)

Annual Holding CostOPT

Number of orders per year = D/Q0

Length of order cycle = Q0/D

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Only one product is involved

Annual demand requirements known

Demand is even throughout the year

Lead time does not vary

Each order is received in a single delivery

There are no quantity discounts

Assumptions of EOQ ModelAssumptions of EOQ Model

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When to Reorder with EOQ OrderingWhen to Reorder with EOQ Ordering

Reorder Point - When the quantity on hand of an item drops to this amount, the item is reordered

Safety Stock - Stock that is held in excess of expected demand due to variable demand rate and/or lead time.

Service Level - Probability that demand will not exceed supply during lead time.

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Determinants of the Reorder PointDeterminants of the Reorder Point

The rate of demand The lead time Demand and/or lead time variability Stockout risk (safety stock)

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Safety StockSafety Stock

LT Time

Expected demandduring lead time

Maximum probable demandduring lead time

ROP

Qu

an

tity

Safety stock

Figure 11.12

Safety stock reduces risk ofstockout during lead time

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Production done in batches or lots Capacity to produce a part exceeds the part’s

usage or demand rate Assumptions of EPQ are similar to EOQ

except orders are received incrementally during production

Economic Production Quantity (EPQ)Economic Production Quantity (EPQ)

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EOQ with Incremental Inventory EOQ with Incremental Inventory ReplenishmentReplenishment

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Economic Run SizeEconomic Run Size

QDS

H

p

p u0

2

Formula (11-5) in page 498 of Chapter 11

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Only one item is involved Annual demand is known Usage rate is constant Usage occurs continually Production occurs periodically Production rate is constant Lead time does not vary No quantity discounts

Economic Production Quantity AssumptionsEconomic Production Quantity Assumptions

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Too much inventory Tends to hide problems Easier to live with problems than to eliminate

them Costly to maintain

Wise strategy Reduce lot sizes Reduce safety stock

Operations StrategyOperations Strategy

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28-Jan-00 29-Jan-99 Change Percent

Current assets:Cash $3,809 $1,726 $2,083 121%Short-term investments 323 923 (600) -65%Account receivables, net 2,608 2,094 514 25%Inventories 391 273 118 43%Other 550 791 (241) -30% Total current assets 7,681 5,807 1,874 32%

Property, plant, and equipment, net 765 523 242 46%Long-term investments 1,048 532 516 97%Equity securities and other investments 1,673 --- 1,673Goodwill and others 304 15 289 1927%

Total assets $11,471 $6,877 $4,594 67%

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:Accounts payable $3,538 $2,397 $1,141 48%Accrued and other 1,654 1,298 356 27% Total current liabilities 5,192 3,695 1,497 41%

Long-term debt 508 512 (4) -1%Other 463 349 114 33%

Total liabilities 6,163 4,556 1,607 35%Stockholders' equity:

Preferred stock --- ---Common stock and capitalin excess of $0.01 per value 3,583 1,781 1,802 101%Retained earnings 1,260 606 654 108%Other 465 (66) 531 Total stockholders' equity 5,308 2,321 2,987 129% Total liabilities and stockholders' equity $11,471 $6,877 $4,594 67%

The Balance Sheet – Dell Computer Co.

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(in millions, except per share amount)28-Jan-00 29-Jan-99

Net revenue $25,265 $18,243Cost of revenue 20,047 14,137Gross margin 5,218 4,106Operating expenses: Selling, general and administrative 2,387 1,788 Research, development, and engineering 568 272 Total operating expenses 2,955 2,060Operating income 2,263 2,046Other income 188 38Income before income taxes 2,451 2,084Provision for income taxes 785 624Net income $1,666 $1,460Earnings per common share: Basic $0.66 $0.58 Diluted $0.61 $0.53Weighted average shares outstanding: Basic 2,536 2,531 Diluted 2,728 2,772Retained Earnings: Balances at beginning of period 606 607 Net income 1,666 1,460 Repurchase of common stocks (1,012) (1,461) Balances at end of period $1,260 $606

Fiscal Year Ended

Income Statement – Dell Computer Co.

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Debt RatioDebt Ratio What It Measures: The extent to which a form uses debt financing How You Compute: The ratio of total debt to total assets

Debt ratio =Total debt

Total assets

$6,

$11,

.

163

471

53 73%

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Inventory Turnover RatioInventory Turnover Ratio

What It Measures: How effectively a firm is managing its inventories.

How You Compute: This ratio is computed by dividing sales by inventories

Inventory turnover ratio =

times

balanceinventoryAverage

Sales

10.76)391$273($

265,25$

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Operations SchedulingChapter 15

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Establishing the timing of the use of equipment, facilities and human activities in an organization

Effective scheduling can yield

Cost savings

Increases in productivity

Scheduling Scheduling

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High-Volume SystemsHigh-Volume Systems

Flow system: High-volume system with Standardized equipment and activities

Flow-shop scheduling: Scheduling for high-volume flow system

Work Center #1 Work Center #2 Output

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High-Volume Success FactorsHigh-Volume Success Factors

Process and product design

Preventive maintenance

Rapid repair when breakdown occurs

Optimal product mixes

Minimization of quality problems

Reliability and timing of supplies

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Scheduling Low-Volume SystemsScheduling Low-Volume Systems

Loading - assignment of jobs to process centers

Sequencing - determining the order in which jobs will be processed

Job-shop scheduling Scheduling for low-volume

systems with many variations in requirements

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Gantt Load ChartGantt Load Chart

Gantt chart - used as a visual aid for loading and scheduling

WorkCenter

Mon. Tues. Wed. Thurs. Fri.

1 Job 3 Job 42 Job 3 Job 73 Job 1 Job 6 Job 74 Job 10

Figure 15.2

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More Gantt ChartsMore Gantt Charts

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SequencingSequencing Sequencing: Determine the order in which jobs at a

work center will be processed. Workstation: An area where one person works,

usually with special equipment, on a specialized job. Priority rules: Simple heuristics used to select the

order in which jobs will be processed.

FCFS - first come, first served

SPT - shortest processing time

Minimizes mean flow time

EDD - earliest due date

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Performance MeasuresPerformance Measures

Job flow time

Length of time a job is at a particular workstation

Includes actual processing time, waiting time, transportation time etc.

Lateness = flow time – due date

Tardiness = max {lateness, 0}

Makespan

Total time needed to complete a group of jobs

Length of time between start of first job and completion of last job

Table 15.2