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Chapter 21

Inventory Management:
Economic Order
Quantity, JIT, and the
Theory of Constraints

Vertue Volcano C1F015016

Fakultas Ekonomi dan Bisnis


Universitas Jenderal
Soedirman
2016

S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Study Objectives

2016

1.

Describe the just-in-case inventory


management model.

2.

Discuss just-in-time (JIT) inventory


management.

3.

Explain the basic concepts of constrained


optimization.

4.

Define the theory of constraints, and tell


how it can be used to manage inventory.

S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Just-in-Case Inventory
Management

2016

Three types of inventory costs can be


readily identified with inventory:
The cost of acquiring inventory.
The cost of holding inventory.
The cost of not having inventory on hand
when needed.

S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Just-in-Case Inventory
Management

2016

Ordering Costs: The costs of placing


and receiving an order.
Examples: Clerical costs, documents,
insurance for shipment, and unloading.

Setup Costs: The costs of preparing


equipment and facilities so they can
be used to produce a particular
product or component.
Examples: Setup labor, lost income (from
idled facilities), and test runs.
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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Just-in-Case Inventory
Management

2016

Stock-Out Costs: The costs of not


having sufficient inventory.
Examples: Lost sales, costs of expediting
(extra setup, transportation, etc.) and the
costs of interrupted production.

Carrying Costs: The costs of


carrying inventory.
Examples: Insurance, inventory taxes,
obsolescence, opportunity cost of capital
tied up in inventory, and storage.
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Just-in-Case Inventory
Management

Just-in-Case Inventory
Management
Economic Order Quantity

TC = PD/Q + CQ/2
Where
TC =
The total ordering (or setup) and
carrying cost
P=
The cost of placing and receiving an
order (or the cost of setting up a production run)
Q=
The number of units ordered each time
an order is placed (or the lot size for production)
D=

The known annual demand

C=
The cost of carrying one unit of stock for
one year
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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Just-in-Case Inventory
Management

2016

Economic Order Quantity illustrated


Assume
P=
$40
per order
D=
25,000 units
C=
$2
per unitEOQ =

2DP C
(2 25,000 50)
40 $2

= 1,000,000
= 1,000

Just-in-Case Inventory
Management
When to Order or Produce
Example: Assume that the average rate of usage is
100 parts per day. Assume also that the
lead time is 4 days. What is the reorder
point?

Reorder point

= rate of usage lead time

= 4 100 = 400 units


An order should be placed when inventory
drops to 400 units.

Just-in-Case Inventory
Management

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Just-in-Case Inventory
Management
Demand Uncertainty and Reordering
To avoid running out of parts, organizations often
choose to carry safety stock (extra inventory
carried to serve as insurance against fluctuations in
demand).
Example: If the maximum
usage of the VCR
part is 120 units per
day, the average
usage is 100 units
per day, and the lead
time is four days, the
safety stock is 80.

Maximum usage
Average usage
Difference
Lead time
Safety stock

120
(100)
20
4
80

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Just-in-Case Inventory
Management

12

S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

JIT Inventory Management

2016

Setup and Carrying Costs: The JIT Approach

JIT reduces the costs of acquiring inventory


to insignificant levels by
Drastically reducing setup time
Using long-term contracts for outside purchases

Carrying costs are reduced to insignificant


levels by reducing inventories to
insignificant levels.

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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

JIT Inventory Management

2016

Avoidance of Shutdown: the JIT


approach

Total preventive maintenance


to reduce machine failures

Total quality control


To reduce defective parts

The Kanban system


To control production
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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

JIT Inventory Management

2016

The Kanban system is responsible for


ensuring that the necessary products are
produced in the necessary quantities at the
necessary time.
A card system is used to monitor work in
process
A withdrawal Kanban
A production Kanban
A vendor Kanban

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JIT Inventory Management

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JIT Inventory Management

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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

JIT Inventory Management

2016

Managing discounts and price increases


Traditional: holding inventories
JIT: negotiate long-term contracts

Vendors
Careful selection; consider more than price
Close to production facility
Establish more extensive supplier involvement

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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

JIT Inventory Management

2016

JIT Limitations
Patience in implementation is needed.
Time is required.
JIT may cause lost sales and stressed
workers.
Production may be interrupted due to an
absence of inventory.

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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Basic Concepts of
Constrained Optimization

2016

Every firm faces limited resources and


limited demand for each product.
External constraints (e.g., market demand)
Internal constraints (e.g., machine or labor time
availability)

Constrained optimization is choosing the


optimal mix given the constraints faced by
the firm.

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Basic Concepts of
Constrained Optimization
Linear Programming
A method that searches among possible solutions until
the optimal solution is identified
Example: Two products, X and Y,
provide contribution
margins of $300 and
$600, respectively.

The objective function:


Z = $300X + $600Y

The objective is to
maximize total
contribution margin.

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Basic Concepts of
Constrained Optimization
Linear Programming

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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Basic Concepts of
Constrained Optimization

2016

Internal constraints:

X+Y 80
X + 3Y 120
2C + Y 90

External constraints:

X 60
Y 100

Linear Programming

X+Y
X + 3Y
2C + Y
X
Y
X
Y

80
120
90
60
100
0
0

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Basic Concepts of
Constrained Optimization

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Basic Concepts of
Constrained Optimization
Linear Programming
Corner Point

X-Value

Y-Value

Z = $300X + $600Y

40

24,000

30

30

27,000

45

13,500

C is the optimal solution!


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Theory of Constraints
Measures of Systems Performance
Throughput*
The rate at which an organization generates
money through sales

Inventory
The money the organization spends in turning
materials into throughput

Operating expenses
The money the organization spends in turning
inventories into throughput
Sales - Unit-level

Rev
Var Exp
*Throughput =
Time

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S1 Akuntansi
Program Alih
Jenjang
STAR BPKP
BATCH 3

Theory of Constraints

2016

Five-Step Method for Improving


Performance

Identify an organizations constraints.

Exploit the binding constraints.

Subordinate everything else to the


decisions made in Step 2.

Elevate the organizations binding


constraints.

Repeat the process as a new constraint


emerges to limit output.
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Theory of Constraints

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Theory of Constraints

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Theory of Constraints

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End Chapter 21
Thank you

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