Overview

Inventory (ABC & EOQ) { Inventory Functions and Types

{ ABC Analysis & Cycle Counting

{ Fixed Period System

MGNT 3430
{ EOQ Inventory Model

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Inventory: Functions & Types Overview

{ Expensive asset { Inventory Functions and Types

{ Functions
z Buffer between demand and
supply { ABC Analysis & Cycle Counting
z Decouple production processes
z Hedge against inflation
z Take advantage of quantity
{ Fixed Period System
discounts
{ Types { EOQ Inventory Model
z Raw material: unprocessed by the
firm
z Work-in-process (WIP): partially
transformed 3 4
 ABC Analysis
Percent
Inventory Classification Item of Percent
Stock Number Annual Annual of Annual
{ ABC Analysis Numbe
r
of Items
Stocked
Volume
(units) x
Unit
Cost =
Dollar
Volume
Dollar
Volume Class
z Pareto principle 72
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
z Classify items as A, B or C %
{ Annual dollar volume #11526 500 154.00 77,000 33.2% A

{ Taking Inventory #12760 1,550 17.00 26,350 11.3% B

z Audit of what is in stock/storage
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z Reconcile purchases and usage #10867 30% 350 42.86 15,001 6.4%
%
B

{ On hand=Purchases - Usage
#10500 1,000 12.50 12,500 5.4% B
{ Cycle counting #12572 600 $ 14.17 $ 8,502 3.7% C

z Taking partial inventory daily #14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% 5% C
z Frequency of counting
#01307 1,200 .42 504 .2% C
{ A items most frequent
#10572 250 .60 150 .1% C
{ C items least frequent 5 6

Cycle Counting
5,000 items in inventory: Overview
500 A items, 1,750 B items, 2,750 C items
Policy is to count: { Inventory Functions and Types
A items every month (20 working days)
B items every quarter (60 days) { ABC Analysis & Cycle Counting
C items every six months (120 days)
Item Cycle Counting Number of Items
Class Quantity Policy Counted per Day { Fixed Period System
500/20 =
A 500 Each month
25/day
B 1,750 Each quarter
1,750/60 = { EOQ Inventory Model
29/day
2,750/120 =
C 2,750 Every 6 months
23/day
77/day
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 Fixed-period system Costs of Inventory
{ Holding Costs
{ Inventory counted at end of period
z Housing/storage
{ Ordering policy is “order up to” type z Material handling & labor
z Set target or par levels for each item z Investment
{ Example: The GAP z Shrinkage & obsolescence
{ Ordering / Setup Costs
Order amount (Q) = z Supplies, processing time, clerical
support
Target – (On-hand inventory) - Earlier orders not
z Machine preparation
yet received + Back orders
{ Unit Costs
9 z Purchase cost per item 10

Overview Basic EOQ Model

{ Inventory Functions and Types
{ ABC Analysis & Cycle Counting
{ Fixed Period System
{ EOQ Inventory Model
Important assumptions
1. Demand is known, constant, and independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and
complete
4. Quantity discounts are not possible
5. Only variable costs are setup and holding
6. Stockouts completely avoidable

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 Inventory Usage Over Time
Minimizing Total Costs
Objective is to minimize total costs
Usage rate Average
Order inventory Curve for total
Inventory level

quantity = Q on hand cost of holding

(maximum and setup
Q
inventory
level) 2 Minimum
total cost

Annual cost
Minimum Holding cost
inventory curve

Setup (or order)

Time cost curve
Optimal Order quantity
Figure 12.3 Table 11.5 order
13 quantity 14

Annual setup cost =
EOQ Model
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the Inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
D D
S Annual setup cost = S
Q EOQ Model Q
Q
Annual holding cost = H
Q = Number of pieces per order 2
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the Inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Annual setup cost = (Number of orders placed per year) Annual holding cost = (Average inventory level)
x (Setup or order cost per order) x (Holding cost per unit per year)

Annual demand Setup or order Order quantity

= = (Holding cost per unit per year)
Number of units in each order cost per order 2

D Q (H)
= (S) =
Q 2

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 D
Annual setup cost = S
EOQ Model Q EOQ Example: optimal order quantity
Q
Annual holding cost = H
Q = Number of pieces per order 2
Q* = Optimal number of pieces per order (EOQ)
Determine optimal number of needles to order
D = Annual demand in units for the Inventory item D = 1,000 units
S = Setup or ordering cost for each order S = $10 per order
H = Holding or carrying cost per unit per year H = $.50 per unit per year
Optimal order quantity is found when annual setup cost
equals annual holding cost 2DS
Q* =
D
S =
Q
H
H
Q 2
Solving for Q* 2(1,000)(10) = 40,000
2DS = Q2H Q* =
Q2 = 2DS/H 0.50 = 200 units
Q* = 2DS/H
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EOQ Example: # of orders/ year EOQ Example: Order cycle length

Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
Determine optimal number of needles to order
S = $10 per order N = 5 orders per year
D = 1,000 units Q* = 200 units
H = $.50 per unit per year
S = $10 per order
H = $.50 per unit per year
Number of working
Expected days per year
Expected Demand D time between = T =
orders N
number of = N = =
orders Order quantity Q*

1,000 250
N= = 5 orders per year T= = 50 days between orders
200 5

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 EOQ Example:New optimal order
EOQ example: Total Cost quantity
Determine optimal number of needles to order Determine optimal number of needles to order
D = 1,000 units Q* = 200 units D = 1,500 units
S = $10 per order N = 5 orders per year S = $10 per order
H = $.50 per unit per year T = 50 days H = $.50 per unit per year

Total (relevant) annual cost = Setup cost + Holding cost

D Q 2DS
TC = S + H Q* =
Q 2 H
1,000 200 2(1,500)(10)
TC = ($10) + ($.50) Q* = = 60,000
200 2
0.50
= 244.9 units
TC = (5)($10) + (100)($.50) = $50 + $50 = $100
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EOQ Robustness: New TC EOQ Robustness: 1st Q* but D=1500

Actual EOQ for new demand is 244.9 units Management underestimated demand by 50%
D = 1,000 units 1,500 units Q* = 244.9 units D = 1,000 units 1,500 units Q* = 200 units
S = $10 per order N = 5 orders per year S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days H = $.50 per unit per year T = 50 days

D Q D Q
TC = S + H TC = S + H
Q 2 Q 2
Only 2% less 1,500 200
1,500 244.9 than the total TC = ($10) + ($.50) = $75 + $50 = $125
TC = ($10) + ($.50) 200 2
244.9 2 cost of $125
when the
TC = $61.24 + $61.24 = $122.48 order quantity Total annual cost increases by only 25%
was 200
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 Robustness of EOQ Homework

{ Discussion Questions
{ 1, 3, 4
• The EOQ model is robust
• It works even if all parameters { Problems
and assumptions are not met { 12.1, 12.4, 12.5, 12.8

• The total cost curve is relatively

flat in the area of the EOQ

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