L6 Inventory Management 1
L6 Inventory Management 1
Inventory turnover =
= = 51.78 Turns/year
INVENTORY COSTS :
1.Holding (or carrying) costs - Includes cost of storage
facilities, handling, insurance, breakage, depreciation,
taxes, and opportunity cost of capital.
2.Set up cost - To make each different product, it involves
obtaining the necessary materials, arranging specific
equipment set up, and moving out the previous stock of
materials. The cost involved in completing these exercises
is called set up cost.
3.Ordering cost - These costs refer to the managerial and clerical
costs to prepare the purchase order. Ordering costs include all the
details, such as preparing bill of materials. The costs associated with
maintaining the system needed to track orders are also included in
ordering cost.
INVENTORY MANAGEMENT
4.Shortage costs - When the stock of an item falls short, an
order for that item must either wait until the stock is
replenished or be cancelled. There is a trade-off between
carrying stock to satisfy demand and the costs resulting
from the stock out. This balance is difficult to obtain,
because it may not be possible to estimate lost profits, the
effects of lost customers, or lateness penalties. The
assumed shortage cost is little more than a guess.
Establishing the correct quantity to order on vendors
involves a search for the minimum total cost resulting from
the combined effects of four individual costs : holding costs,
setup costs, ordering costs and shortage costs.
INVENTORY MANAGEMENT
Multi period Inventory System
Multi period inventory systems are designed to ensure that
an item will be available on an ongoing basis throughout
the year. Usually the item will be ordered multiple times
throughout the year where the logic in the system dictates
the actual quantity ordered and the timing of the order.
1.Fixed-order Quantity Models (also called Economic Order
Quantity, EOQ, and Q-Model).
2.Fixed Time Period Models (referred to as Periodic system,
Periodic Review System, Fixed Order Interval System, and
P-Model)
INVENTORY MANAGEMENT
Difference between Q-Model & P-Model
Feature Q-Model (Fixed order P-Model (Fixed-Time
quantity model) period model)
Order Quantity Same amount ordered Quantity varies each
each time time order is placed
When to place When inventory level When review period
order drops to reorder level arrives
Record keeping Each time a withdrawal Counted only at
or addition is made review period
Size of inventory Less than fixed-time Larger than fixed-
period model order quantity model
Time to maintain Higher due to perpetual
record keeping
INVENTORY MANAGEMENT
FIXED-ORDER QUANTITY MODEL
Fixed-order quantity model attempts to determine the
specific point, R at which an order will be placed, and the
size of that order, Q. Inventory position is defined as :
Inventory position = Inventory on hand + Inventory on
order – Backordered quantity
Assumptions for developing Q-Model
• Demand for the product is constant and uniform
throughout the period
• Lead Time (Time from ordering to receive) is constant
• Price per unit of product is constant
• Inventory holding cost is based on average inventory
INVENTORY MANAGEMENT
• Ordering or setup costs are constant
• All demands for the product will be satisfied (No
backorders are allowed).
Total = Annual + Annual + Annual
Annual cost purchasing cost ordering cost holding
cost
TC = DC + + H
TC = Total annual cost, S=Setup cost/cost of placing an
order
D = Annual demand R=Reorder point
C=Cost/Unit L=Lead Time
Q= Quantity to be H=Annual holding or storage cost
ordered, EOQ per unit of average inventory
INVENTORY MANAGEMENT
The second step in model development is to find out the
optimum order quantity, QOPT at which the total cost is
minimal. Using calculus, we take the derivative of total cost
with respect to Q and set this equal to zero.
TC = DC + S + H
=0+()+ = 0
QOPT = )
Reorder point, R = d.L
d = Average daily demand (constant)
L = Lead Time in days (constant)
UNIT – III : INVENTORY MANAGEMENT