BUSOBA 3230: Inventory Management

BOOK

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Fixed Order Quantity Model

• Used when we want to maintain an item "in-stock" and when we resupply the item, a certain number of units must be ordered each time.

• Inventory is monitored until it gets down to a level where the risk of stocking out is great enough that we are compelled to order.

• Also known as the economic order quantity, EOQ, and Q-model.

Fixed Order Quantity Model (Q-Model)

An inventory control model where the amount requisitioned is fixed and the actual ordering is triggered by inventory dropping to a specified level of inventory.

Fixed Order Quantity Model Info.:

• Order quantity: Q - constant
• When to place order: R - when the inventory position drops to the reorder level.
• Recordkeeping: Each time a withdrawal or addition is made
• Size of inventory: Less than fixed - time period model
• Time to maintain: Higher due to perpetual record keeping
• Type of items: Higher priced, critical, or important items

Inventory

• All the money that the system has invested in purchasing things it intends to sell (Goldratt's definition).
• The stock of any item or resource used in an organization.

Firms keep a supply of inventory for the following reasons:

• Maintain independence of operations.
• Meet variation in product demand.
• Allow flexibility in production scheduling.
• Provide a safeguard for variation in raw materials delivery time.
• Take advantage of economic purchase order size.
• Many other domain specific reasons.

Independent and dependent demand determines…

whether demand is derived from an end item or is related to the item itself.

Independent Demand

• The demands for these items are unrelated to each other, or to activities that can be predicted with certainty.

Dependent Demand

• The need for an item is a direct result of the need for some other item, usually an item of which it is a part. Also, when the demand for the item can be predicted with accuracy due to a schedule or specific activity.

Optimal Order Quantity (Qopt)

This order size minimizes total annual cost.

Reorder Point (R)

An order is placed when inventory drops to this level.

Safety Stock

• The amount of inventory carried in addition to the expected demand.
• In a normal distribution, this would be the mean.

The difference between a fixed-order quantity model where demand is known and one where demand is uncertain is in…

computing the reorder point. The order quantity is the same in both cases.

Pareto Principle

• The logic of the few having the greatest importance and the many having little importance has been broadened to include many situations.
• This is true in inventory systems (where a few items account for the bulk of our investment).

ABC Inventory Classification

• Divides inventory into dollar volume categories that map into strategies appropriate for the category.
• The three groupings are: high dollar volume (A), moderate dollar volume (B), and low dollar volume (C).
• Dollar volume is a measure of importance; an item low in cost but high in volume can be more important than a high-cost item with low volume.

PP LEC

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Inventory

• A stock to satisfy internal or external demand.

Inputs/Raw Materials

• Too much to manage.
• Too expensive.
• Too much capital.

Outputs/Finished Goods

• Too little to manage.
• More expensive than raw materials. Value has been added.
• Lose sales.
• Lose customers.
• Poor customer service.

ABC Analysis

Separately vital few from trivial many. Based on pareto principle.

Lead Time L=0,

• demand is constant (known, no uncertainty)
• Demand during lead time.

When to order: L=0, demand is constant

reorder point.

L>0,

demand is constant

When to order: L>0, demand is constant

Order early enough to have enough remaining inventory to cover demand during lead time.

L>0 & constant,

• demand is NOT constant
• Being constant is not realistic.
• Demand is NOT constant is uncertainty and real life.

When to order: L>0 & constant, demand is NOT constant

• Carry extra inventory to cover uncertainty of demand during lead time.
• Order a little extra, not more.

Pressures For Large Inventories

• Quality discounts.
• Setup costs (fixed).
• Ordering cost.
• Transportation or shipping cost.

Pressures for Small Inventories

• Cost of capital.
• Inventory holding cost.
• Shrinkage.
• Spoilage/expiration.

OTHER

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Inventory Position

The amount on-hand plus on-order minus backordered quantities. In the case where inventory has been allocated for special purposes, the inventory position is reduced by these allocated amounts.

Inventory Turn

The cost of goods sold divided by the total average value of inventory. A measure of the expected number of times that inventory is replaced each year.

R5

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If demand constant, supply lead times are fixed, inventory items are independent items, and there are no quantity discounts, then

• economic order quantity (EOQ) calculates the minimum total annual cost of ordering and holding inventory.

The only relevant costs for EOQ are

ordering (a.k.a., "setup") costs and holding (a.k.a., carrying) costs.

High holding costs drive Q (orEOQ)

down

high ordering costs drive Q (or EOQ)

up

Inventory is held in

different places (e.g., raw material, work in process, finished goods).

Accountants place an economic value on

inventory based on value added, so raw materials are valued lower.

An ABC approach prioritizes

• inventory based on dollar usage (cost x volume).
• It is useful to recognize disproportionate impact from certain SKUs (e.g. 20% of the SKU's represent 80% of the dollar inventory usage).