chap 017 inventory

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McGraw-Hill/Irwin Copyright 2011 The McGraw-Hill Companies, All Rights Reserved

Chapter 17

Inventory Control


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Learning Objectives

1. Explain the different purposes for keeping inventory.

2. Understand that the type of inventory system logic thatis appropriate for an item depends on the type ofdemand for that item.

3. Calculate the appropriate order size when a one-timepurchase must be made.

4. Describe what the economic order quantity is and howto calculate it.

5. Summarize fixedorder quantity and fixedtime period

models, including ways to determine safety stock whenthere is variability in demand.

6. Discuss why inventory turn is directly related to orderquantity and safety stock.


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Inventory

You should visualize inventory as stacks ofmoney sitting on forklifts, on shelves, and intrucks and planes while in transit

For many businesses, inventory is the largestasset on the balance sheet at any given time

Inventory is often not very liquid

It is a good idea to try to get your inventory

down as far as possible The average cost of inventory in the United States

is 30 to 35 percent of its value

LO 1


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Supply Chain InventoriesMake-to-Stock Environment

LO 1


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Models Discussed

1. The single-period model

Used when we are making a one-timepurchase of an item

2. Fixedorder quantity model

Used when we want to maintain an itemin-stock, and when we restock, a certainnumber of units must be ordered

3. Fixedtime period model

The item is ordered at certain intervals oftime

LO 2


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Definition of Inventory

Inventory: the stock of any item or resourceused in an organization and can include: rawmaterials, finished products, component parts,

supplies, and work-in-process Manufacturing inventory: refers to items that

contribute to or become part of a firms product

Inventory system: the set of policies and

controls that monitor levels of inventory anddetermines what levels should be maintained,when stock should be replenished, and howlarge orders should be

LO 2


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Purposes of Inventory

1. To maintain independence ofoperations

2. To meet variation in product demand

3. To allow flexibility in productionscheduling

4. To provide a safeguard for variation in

raw material delivery time

5. To take advantage of economicpurchase-order size

LO 2


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Inventory Costs

1. Holding (or carrying) costs Costs for storage, handling, insurance,

and so on

2. Setup (or production change) costs Costs for arranging specific equipment

setups, and so on

3. Ordering costs

Costs of placing an order

4. Shortage costs Costs of running out

LO 3


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Independent Versus DependentDemand

Independent demand: the demandsfor various items are unrelated to eachother

For example, a workstation may producemany parts that are unrelated but meetsome external demand requirement

Dependent demand: the need for any

one item is a direct result of the needfor some other item Usually a higher-level item of which it is

part

LO 2


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Inventory Control-System Design Matrix:Framework Describing Inventory ControlLogic

LO 2


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Inventory Systems

Single-period inventory model One time purchasing decision (Example:

vendor selling t-shirts at a football game)

Seeks to balance the costs of inventoryoverstock and under stock

Multi-period inventory models Fixed-order quantity models

Event triggered (Example: running out of stock)

Fixed-time period models Time triggered (Example: Monthly sales call by

sales representative)

LO 2


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A Single-Period Inventory Model

Consider the problem of deciding howmany newspapers to put in a hotellobby

Too few papers and some customerswill not be able to purchase a paperand they will lose the profit associatedwith these sales

Too many papers and will have paid forpapers that were not sold during theday, lowering profit

LO 3


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A Simple View of the Problem

Consider how much risk we are willingto take for running out of inventory

Assume a mean of 90 papers and a

standard deviation of 10 papers Assume they want an 80 percent

chance of not running out

Assuming that the probabilitydistribution associated of sales isnormal, stocking 90 papers yields a 50percent chance of stocking out

LO 3


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A Simple View of the Problem Continued

To be 80 percent sure of not stockingout, we need to carry a few more than90 papers

From the cumulative standard normal

distribution table, we see that we need

approximately 0.85 standard deviation

of extra papers to be 80 percent sure ofnot stocking out

With Excel, =NORMSINV(0.8) = 0.84162

LO 3


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Single-Period Inventory ModelFormulas

We should increase the size of the inventory solong as the probability of selling the last unit addedis equal to or greater than the ratio of Cu/Co+Cu

soldbeunit willy that theProbabilit

estimatedunderdemandofunitperCostC

estimatedoverdemandofunitperCostC

:Where

u

o

P

CC

CP

uo

u

LO 3


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17-16

Example 17.1

Mean of 5

Standard deviation of 3

Cost $80 Overbook cost is $200

2857.080$200$

80$

UO

U

CC

CP

LO 3


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17-17

Calculations

LO 3


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Multi-Period Models

There are two general types of multi-period inventory systems

1. Fixedorder quantity models

Also called the economic order quantity, EOQ,and Q-model

Event triggered

2. Fixedtime period models

Also called the periodic system, periodicreview system, fixed-order interval system,and P-model

Time triggered

LO 5


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Key Differences

To use the fixedorder quantity model,the inventory remaining must becontinually monitored

In a fixedtime period model, countingtakes place only at the review period

The fixedtime period model Has a larger average inventory

Favors more expensive items

Is more appropriate for important items

Requires more time to maintain

LO 5


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FixedOrder Quantity and FixedTime Period Differences

LO 5


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Comparison for FixedOrder Quantityand FixedTime Period InventorySystems

LO 5


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Fixed-Order Quantity ModelModels

Demand for the product is constant anduniform throughout the period

Lead time (time from ordering to

receipt) is constant Price per unit of product is constant

Inventory holding cost is based onaverage inventory

Ordering or setup costs are constant

All demands for the product will besatisfied

LO 4


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Basic FixedOrder Quantity Model

Place OrderLead time

Receive order

Use inventory

LO 4


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Basic Fixed-Order Quantity (EOQ)Model Formula

inventoryofunitpercoststorageandholdingAnnualH

timeLeadL

pointReorderRcostsetupororderanplacingofCostS

quantityOrderQ

unitperCostC

DemandD

costannualTotalTC

H2

Q+S

Q

D+DC=TC

LO 4


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Annual Product Costs, Based onSize of the Order

LO 4


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Example 17.2

81.611,12$63.55$18.56$500,12$

25.1$2

895$

89

000,150.12$000,1

2

7.135365

000,1

4.89000,825.1

5000,122

$12.50Cdays5L

yearperunitper$1.25H

orderper$5S

1,000/365d

units1,000D

HQ

SQ

DDCTC

unitsLdR

unitsH

DSQopt

LO 4


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Establishing Safety Stock Levels

Safety stock: amount of inventory carried inaddition to expected demand Safety stock can be determined based on many

different criteria

A common approach is to simply keep acertain number of weeks of supply

A better approach is to use probability

Assume demand is normally distributed Assume we know mean and standard deviation

To determine probability, we plot a normaldistribution for expected demand and note where theamount we have lies on the curve

LO 4


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FixedOrder Quantity Model withSafety Stock

LO 5


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FixedOrder Quantity Model withSafety Stock

timeleadduringusageofdeviationStandard

yprobabilitserviceafordeviationsstandardofNumberz

daysintimeLeadLdemanddailyAveraged

unitsinpointReorderR

L

LzLdR

LO 5


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Example 17.4

6

50.0$

10$

7

900,2136560

60

L

H

S

D

d

d

units

zLdR

L

units

H

DSQ

L

d

L

i

dL

opt

388

15.1764.1660

15.1776

936

50.0

10900,212

2

22

1

2

LO 5


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Fixed-Time Period Models

order)onitems(includeslevelinventorycurrent=I

timeleadandreviewover thedemandofdeviationstandard=

yprobabilitservicespecifiedafordeviationsstandardofnumberthe=zdemanddailyaverageforecast=d

daysintimelead=L

reviewsbetweendaysofnumberthe=T

orderedbetoquantitiy=q:Where

I-Z+L)+(Td=q

L+T

L+T

Order quantityAverage daily

demand

Vulnerable periodSafety stockInventory on hand

LO 5


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FixedTime Period Inventory Model

LO 5


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units

q

LT

IzLTdq

d

LT

i

dLT

LT

LT

331

1509.1905.2143010

9.1931430

15005.2143010

22

1

2

Example 17.5

Daily demand of 10units

Daily standarddeviation of 3 units

Review period of 30days

Lead time of 14 days

Satisfying 98 percentof demand from itemsin stock

150 Units in inventory

LO 5


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Inventory Control and SupplyChain Management

SS

SS

2Q

D

turnInventory

2

QinventoryAverage

LO 6


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Price Break Models

Price varies with the order size

To find the lowest-cost, need to calculate theorder quantity for each price and see if the

quantity is feasible1. Sort prices from lowest to highest and calculate

the order quantity for each price until a feasibleorder quantity is found

2. If the first feasible order quantity is the lowest

price, this is best, otherwise, calculate the totalcost for the first feasible quantity and calculatetotal cost at each price lower than the first feasibleorder quantity

LO 4


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Curves for Three Separate OrderQuantity Models in a Three-Price-BreakSituation

LO 4


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Example 17.8: The Data and OrderQuantities

D = 10,000

S = $20

i = 20 percent

Cost per unit

1-499 $5.00

500-999 $4.50

1,000 and up $3.90

71690.320.0

20000,102

66750.420.0

20000,102

63300.520.0

20000,102

2

000,1

999500

4991

Q

Q

Q

iC

DSQ

LO 4


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Example 17.8: The Solution

LO 4


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ABC Classification

LO 2


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Inventory Accuracy and CycleCounting

Inventory accuracy: refers to how wellthe inventory records agree withphysical count

Cycle counting: a physical inventory-taking technique in which inventory iscounted on a frequent basis rather than

once or twice a year

LO 2

chap 017 inventory

Documents

inventory turn

inventory costs1

inventory control5202018

average cost of inventory

given time inventory

firms product inventory

inventory controlsystem

ordering costs costs