Inventory Control

Unit- V
Lecture-1: Introduction
 Definition of Inventory
• A broad term which refers to the stock of
materials that are to be handled by Enterprise
from time to time

• Every Organization based on the size of the

product, requires a considerable number of
materials to acquire, to store and utilize from time
to time
 Inventory Control or Management

• Inventory Control or Management is the process

of directing the movement of goods or
commodities through the entire manufacturing
cycle from the time of acquiring raw materials to
finished goods inventory
 Objectives
• Maximum Customers Service
• Minimum Investments on materials
• Efficient or Low-cost Plant Operation
 Inventory as an Important Asset
• Inventory can be the most expensive and the most
important asset for an organization

Inventory as a
percentage of total assets
Inventory
40%

Other Assets
60%
 The Inventory Process
Suppliers Customers

Inventory Storage
Raw Finished
Materials Goods

Fabrication
Work in and
Process Assembly

Inventory Processing
Importance of Inventory Control
Five Functions of Inventory
 Decoupling
 Storing resources
 Responding to irregular supply and demand
 Taking advantage of quantity discounts
 Avoiding stockouts and shortages
 Inventory Decisions
Two fundamental decisions in controlling inventory:

1. How much to order ?

Quantity = (Order / Size)

Based on Demand and Supply

2. When to Order ? (Re-Order Level – ROL)

Ex: Fixed Order System, Fixed Period System

Overall goal is to minimize

total inventory cost
 Basic Characteristics of an Inventory System

1. Relevant Inventory Costs

2. Demand element of a System
3. Order Cycle
4. Lead Time
5. Stock Replenishment
6. Time Horizon
7. No. of items
8.a) Max. Stock b) Safety stock/min. cost/Buffer Cost
9.a) Re-order level b) Re-order Quantity
 Inventory Costs
 Purchase Cost
 Ordering or Setup Cost (No. of orders X Cost per order)
 Holding or Carrying Cost (Average Inventory X Holding
cost/unit)

 Shortage or Backorder cost (No. of units short x Shortage

cost/unit)
 Purchase Cost
• Purchase Cost: It is the actual price, paid for the
procurement of items
The components of the cost include:
i. Direct material cost ii. Direct Labor Cost
iii. Direct Expenses iv. Overhead Cost v. Profit
of the manufacturer
Purchase Cost = (Price per unit) X (Demand per
 Ordering Costs
• Ordering Costs (% of acquisition or Replenishing
or setup costs)
 Ordering Costs
• Developing and sending purchase orders
• Processing and inspecting incoming inventory
• Bill paying
• Inventory inquiries
• Utilities, phone bills, etc., for the purchasing department
• Salaries/wages for purchasing department employees
• Supplies (e.g., forms and paper) for the purchasing
department
 Carrying Costs
• Cost of capital
• Taxes
• Insurance
• Spoilage
• Theft
• Obsolescence
• Salaries/wages for warehouse employees
• Utilities/building costs for the warehouse
• Supplies (e.g., forms, paper) for the warehouse
Sawtooth Inventory Curve
Inventory Usage Over Time - Fig. 6.2
 Costs as Functions of Order Quantity - Fig. 6.3

Annual
Cost Total Cost Curve
Carrying (holding)
Cost Curve

Minimum Cost
Ordering (set-up)
Cost Curve

Q* Order Quantity
 EOQ : Basic Assumptions

1. Demand is known and constant.

2. Lead time is known and constant.
3. Receipt of inventory is instantaneous.
4. Quantity discounts are not possible.
5. The only variable costs: set-up or placing an order, and holding or storing
inventory over time.
6. Stockouts can be completely avoided if orders are placed at the appropriate
time.
 Steps in Finding the Optimum Inventory

• Develop an expression for the ordering cost.

• Develop and expression for the carrying cost.
• Set the ordering cost equal to the carrying cost.
• Solve this equation for the optimal order
quantity, Q*.
 Developing the EOQ

 Annual ordering cost: 

Annual demand
Number of units per order
D
 Co
Q

 Annual holding or carrying cost:  Average Inventory * Carrying Cost Per Year
Q
 Ch
2

 Total inventory cost: D Q

C t  C o  C h
Q 2
Setting the Equations Equal to Solve for Q*
 Per Unit vs. Percentage Carrying Cost

Typically, carrying cost, Ch, is stated in

per unit $ cost
per year

Sometimes, an annual Interest rate, i, is cited and Ch must be

calculated
i multiplied by C (unit cost)

iC then replaces Ch
 EOQ
Per Unit Carrying Cost:

Q* = 2DC o
Ch

Percentage Carrying Cost: Denominator

Change

* = 2DC o
Q IC
 The Reorder Point (ROP) Curve
ROP = (Demand per day) x (Lead time for a new order, in days)

= dxL
Q*
Slope = Units/Day = d
Inventory Level

ROP
(Units)

(Units)

Lead Time (Days) L

 Hubungan
Hubungan EOQEOQ denganReoder
dengan ROP pada kondisi
point padayang pasti
kondisi yang pasti

Persediaan Maksimum = EOQ

EOQ EOQ
EOQ

ROP ROP ROP

Lt Lt Lt
 Pengembangan model EOQ untuk keadaan yang tidak
Hubungan EOQ dengan ROP pastidan
PersediaanPengaman

Persediaan Maksimum = EOQ + Persed. Pengaman

EOQ EOQ EOQ

ROP ROP ROP

Persediaan pengaman
 Production Quantity EOQ

Annual Carrying Cost:

Annual Setup or Ordering Cost:

Setup Cost:

Ordering Costs:
 Production Quantity EOQ

If production is not the cause of delayed receipts, use the

same model but replace C with C
s o
 Brown Manufacturing Example

• Annual demand (D) = 10,000 units

• Setup cost (Cs) = $100
• Carrying cost (Ch) = $0.50 per unit per year
• Production rate (p) = 80 units daily
• Demand rate (d) = 60 units daily

• Refrigeration operational days = 167 days per year

 Brown Manufacturing Example continued

1. How many refrigeration units should Brown

produce in each batch?
– i.e., What is Qp*?
2. How long should the production cycle last ?
– i.e., What is Q/p?
 Brown Manufacturing Example continued

1. What is Qp*?
* 2DCs
Q p =
æç _ d ö÷
Ch çè1 p ÷ø

* 2(10,000)(100)
Q p =
æ
(0.5) ç 1 _ 60 ö÷
çè 80 ÷ø
*
Q p = 4,000 units
 Brown Manufacturing Example continued

2. How long should the production cycle last ? What is t

(Q/p)?
*
Q p = 4,000 units
p = 80 units per day
t = Q/p = 4,000/80 = 50 days
Production runs will cover 50 days and
produce 4,000 units
 Quantity Discount Models

 Object is to Minimize total inventory costs; includes material

costs
 Material costs relevant in total cost:
 TC = DC + D/Q(Co) + Q/2(Ch)
where
o D = unit annual demand
o C = unit cost
o Co = each order cost
o Ch = carrying cost per unit per year
IC must be used in place of Ch in decision-making
 Steps for Solving Quantity Discount

1. Compute EOQ for each discount price:

* 2DC o
Q = IC
2. If EOQ < discount minimum level, make Q = minimum.

3. For each EOQ, compute total cost:

1. TC = DC + D/Q(Co) + Q/2(Ch)

4. Choose the lowest cost quantity from all levels.

 Quantity Discount Models

Text example:
Quantity Discount Schedule

Material cost:
• Total material cost is affected by the
Discount (%)
• Unit cost if first $5.00, then $4.80,
and finally $4.75
Quantity Discount Steps – A Review

1. Calculate Q for each discount.

2. Adjust Q upward if quantity is too low for discount.
3. Compute total cost for each discount.
4. Select Q with the the lowest total cost.
 Example

The Smith company purchases 8000 units of a product

each year. The supplier offers the units for sale at $10.00
per unit for orders up to 500 units and at $9.00 per unit
for orders of 500 units or more. What is the economic
order quantity if the order cost is $30.00 per order and
the holding cost is 30% of per unit cost per year?
 Quantity Discount Example

The EOQ at $9.00 is invalid, since it is not available for quantities less than 500
units. The EOQ at $10.00 is valid. Therefore, the total cost of the valid EOQ is
compared with the total cost at the larger price-break quantity:

Comparing the total costs of the single price-break quantity and the valid EOQ ,
the minimum cost order quantity is 500 units.
 The Use of Safety Stock
Stockouts occur when there are uncertainties with:
• Demand
• Lead time

Safety stock is extra stock on hand to avoid stockouts

ROP is adjusted to implement safety stock policy:

ROP = d*L + SS
d = average daily demand
L = average lead time, time for an order to be delivered
SS = safety stock
 ABC Analysis

ABC analysis divides on-hand inventory into three

classifications on the basis of dollar (TL) volume.

It is also known as Pareto analysis. (which is named after

principles dictated by Pareto).

The idea is to focus resources on the critical few and

not on the trivial many.

(Annual Dollar Volume of an Item) = (Its Annual

Demand) x (Its Cost per unit)
 ABC Analysis

Class A items are those on which the

annual dollar volume is high.

They represent 70-80% of total

inventory costs, but they
account for only 15% of total
inventory items.
 ABC Analysis

Class B items are those on

which annual dollar volume is
medium.

They represent 15-25% of total

dollar value, and they account
for 30% of total inventory items
on the average.
 ABC Analysis

Class C items are low dollar

volume items.

They represent only the 5% of

total dollar volume, but they
include as many as 50-60% of
total inventory items.
ABC Analysis
 ABC Inventory Policies

 Greater expenditure on supplier development for

A items than for B items or C items
 Tighter physical control on A items than on B
items or on C items
 Greater expenditure on forecasting A items than
on B items or on C items