Managing Independent Inventory

Chris Jarvis

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Overview

What is an inventory system and why hold stock? Textbook prescriptions versus reality and variety? Independent versus Dependent Demand Inventory types, flows, costs Re-order quantities, EOQ & calculations Safety stocks & service levels Review systems Discounts and staged deliveries JIT ABC Analysis Stock taking Make or buy
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What is an Inventory System?

Inventory

the stock of any item or resource used in an organization: raw

materials, finished products, component parts, supplies and work-in-process. An inventory system

policies and controls for monitoring levels of inventory Information system that records transactions and enables
analysis of stock requirements and levels/quantities, costs etc

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Organisations, Roles, Methods and Systems?

What type of organisations use systematic inventory management methods? How are the methods manifested? How is inventory management linked to aggregrate planning, buying for MRP, JIT, retail buying, sales
systems, accounting practice?

Who does it? buyers, store keepers, production planners, accountants? What manual & IT-based systems are involved? Stock cards, orders, delivery notes, GRNs, return advice notes, Are textbook methods really used? How, where? What is the clerical burden of inventory analysis and control?
Chris Jarvis

inventory module in integrated accounting packages, stock checks and auditing.

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Independent vs. Dependent Demand

Independent Demand (not related to other items or final end-product) Dependent Demand (derived from component parts, sub-assemblies, raw materials, etc.)

E(1 )

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Independent versus Dependent Demand

Demand/usage

Independent demand - finished goods - spare parts

Time

Demand/usage

Dependent demand Work in progress Components and raw materials

Time
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Why hold stock?

Provide flexibility

Protect against uncertainties Enable economic purchasing Anticipate changes in demand or supply
scheduling Strategic stock holdings
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minimum delay in supplying customers a good range

Buffers to feed processes and enable efficient

Chris Jarvis

Inventory Types

Raw-materials, components and sub-assemblies Work-in-progress or in-transit Finished-goods

Strategic inventory Scrap & re-work

Chris Jarvis

In the warehouse, awaiting shipment, in delivery vehicles, in tanks, on shelves, in the stores

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Material-Flows Process

Production Processes Work in process

Stores warehouse

To Customer

WIP WIP

Finished goods

Inventory in transit

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Stock : Input (Flow in), Storage (Holding) and Flow out (Usage)

Inventory Level
Supply Rate

Stock Level

Rate of Demand (Usage)

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Costs of Inventory

Ordering costs purchase order & office, shipping and/or set up Holding Costs
tied up capital (item value), staff & equipment,

obsolescence, perishability, shrinkage, insurance & security, m2 - m3 (rent/lease), audit. Cost of being out of stock, cancelling an order Scrap and re-working

annual costs = holding cost factor % average value of stockholding e.g. 25% or 2p in per month of stock
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Order Quantities & Reorder Points

Average stock q/2

No. of units on hand

q R

safety or buffer level

Time

L
R = Reorder point L = Lead time

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Simple inventory system

Orders MRP Check stock level

Next Check point

No
<=ROL?

Yes No
Outstanding Order?

Yes

Due now?

Yes

No

Receive/inspect. Accept into stock Send back? Part-delivery

Raise order for ROQ

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Bin systems

Two-Bin - quantity stock in bin 2 = re-order level

Full Empty

Order one bin

One-Bin (periodic check)

Order enough to refill bin?
ROQ Options

Keep order costs to a minimum? Order one year's supply in one go? OR Hand-to-mouth, once per week?
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EOQ Aim = Cost Minimisation

Holding + ordering costs = total cost curve. Find Qeoq inventory order point to minimise total costs.

Total Cost
Cost

Holding Costs Ordering Costs

Qeoq
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Order Quantity (Q)

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Calculate EOQ

Qeoq =

2DS = H

2(Annual Demand)(Order or set-up cost) Annual Holding Cost

when to place an order. Reorder point R=DL D = Avg daily demand (constant) L = Lead time (constant)
Exercise EOQ and reorder point? Annual demand = 2,000 units Days/year in average daily demand = 365 Cost to place an order = 10 Holding cost /unit p.a. = 2.50 Lead time = 7 days Cost per unit = 15
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EOQ Solution

Q eoq =

2DS = H

2(1,000 )(10) 2.50

= 89.443 units or 90 units

1,000 units p.a. d = = 2.74 units/day 365 days p.a.

Reorder point D L = 2.74 units/day = 19.18 or 20 for 7 day lead time

EOQ order = 90 units.

When only 20 units left, place next order for 90 units.

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EOQ and ROQ example 2

Annual Demand = 10,000 units Days per year considered in average daily demand = 365 Cost to place an order = 10 Holding cost per unit per year = 10% of cost per unit Lead time = 10 days Cost per unit = 15 2DS Q eoq = H = 2(10,000)(10) 1.50 = 365.148 (366 units)

D=

10,000 units/year 365 days

= 27.397 units/day

If lead time = 10 days, ROL= 273.97 = 274 units Place order for 366 units. When 274 left, place next order for 366.
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Total variable cost

Avg.stock

Demand 2
Once per year

x unit cost x Hc% + Oc 1200 2 x 3 x 25% = 450 + 10 = 460

Once per week

1200/52 x 3 x 25% = 9 + 510 2 = 519 approx

Find point of minimum TVc

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EOQ Table minimum TVc Avg.stock x item x hc % Oc + Hc

Item 3 Holding cost % = 25% No. of Quantity Order Average Holding Total orders Ordered cost stock cost cost 1 1200 10 600 450 2 600 20 300 225 3 400 30 200 150 4 300 40 150 113 6 200 60 100 75 8 150 80 75 56 10 120 100 60 45 12 100 120 50 38
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460 245 180 153 135 136 145 158

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Minimum point of Total Inventory Costs

EOQ = minimum TVc point

Costs

Total variable costs Total Hc

Total Oc EOQ*
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Order Size (Q)

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EOQ Example

Cheapo Bags wants to calculate the EOQ for tapestry cloth used to produce hand bags. Last year demand = 10,000 metres (constant rate). Value per metre of tapestry = 6.40 Oc each order = 250. Hc = 1.20 per metre = 18.75% What is the EOQ? 2 x 10,000 x 250

6.40 x 18.75%

= 2042 metres

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Economic Order Quantity (EOQ) Assumptions

Single product line Demand rate: recurring, known, constant Lead time: constant , known No quantity discounts - stable unit cost No stock-outs allowed Items ordered/produced in a lot or batch Batch received all at once Holding cost is linear based on average stock level Fixed order + set up cost

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Order Point with Safety Stock

2200 2000 Actual lead time is 3 days! (at day 21)

Units

Order Point 400 200

Dip into safety stock

Safety Stock
0 18 21

Days
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Safety Stock and Re-order Levels

Reserve - buffer - cushion against uncertain demand

(usage) & lead time.

A basis for a "2-bin" system Application to JIT?

EOQ assumes certain demand & lead time. If uncertain, then: ROL =

Average usage in lead time + safety stock

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(Avg. lead time x Avg. daily usage)

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How Much Safety Stock? Cost vs. safety level

Depends on:

Uncertainty: demand & lead time cost of being out of stock carrying inventory increasingly better service
Service level policy % confidence of not hitting a stock-out situation

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Cost vs service level

Cost of poor service (out-of-stock) Loss of -part order -future order -customer goodwill -buying from non-regular sources

Cost of better and better service

0
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Service level

70 80 90 100 % 27

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Normal Distribution of Demand over Lead Time

m = mean demand r = reorder point s = safety stock

service level probability

frequency
probability of stock out

m
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r 28

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demand over lead time

Service level protection

ROL = Average usage in lead time + Safety stock

(Avg. usage (day/week) x Avg. Lead time)

K x stdev demand x
Confidence of % non stock out K = 2 for 97.5 confidence K = 3 for 99.87

Avg. lead time

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ROL AND Service Level Example ROL = Average usage in lead time + Safety stock
(Avg. usage day/week x Avg. lead time) K x stdev demand x Avg. lead time

ROL = (250 per week x 4 weeks) + ( 2 x 50 x (4) ) = 1000 + 200 = 1200

Stock falls to or below ROL & no order is outstanding? Place a new order for 1200. Service level @ 97.5% stock-out for 1 in 40 reorder situations.
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Review Systems

Top-up with regular review

Stock not to exceed upper limit (perishables, corrosives,

limited capacity) use with regular review (continuous or periodic) Continuous review relax constant demand assumption Continuous system to monitor stock-on-hand Periodic review Apply EOQ (demand constant + no stock-out) orders must be placed at specified intervals. Use when multiple, items ordered from same supplier (jointreplenishment) inexpensive items
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Chris Jarvis

Price discounts and staged deliveries

Quantity Discounts, buying frequency & Oc, Hc Staged deliveries & EOQ?
more storage space different payment terms if demand changes surplus stock Extra delivery & handling cost? Assumes constant order cost Requires reliable deliveries & steady demand JIT collaborative supplier relationships Affect on supplier (locate nearer customer?)

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Price-Break Model

Assumptions similar to as EOQ model

2DS QOPT = = iC 2(Demand p.a.)(Order or Setup-cost) Holding cost per annum
i = % of unit cost as carrying cost C = cost per unit

C varies for each price-break so apply the formula to each price-break cost value.

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Price-Break Example

Brunel University can reduce ordering costs for photocopy paper by placing larger quantity orders. What is the optimal order quantity? e-mail order cost = 4 carrying cost % = 2% Demand p.a. = 10,000 units?
Order Quantity(units)
Quantity price breaks

2DS iC

Price/unit()

0 to 2,499 2,500 to 3,999 4,000 or more

1.20 1.00 0.98

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Solution Put data into formula for each price-break of C.

D = 10,000 units Order cost (S) = 4

Carrying cost % (i) = 2% Cost per unit (C) = 1.20, 1.00, 0.98

Are Qopt values feasible for the price breaks?

2DS = iC

2(10,000)(4) = 1,826 units 0.02(1.20)

2(10,000)(4) =2,000 0.02(1.00) 2(10,000)( 4) =2,020

=
Qopt 0 - 2499 Feasible 2500-3999 and 4000+ Not feasible
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0.02(0.98)

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U-shaped function

True Qopt values occur at the start of each price-break interval.The total annual cost function is a u shaped function Total annual costs

Price-breaks

1826

2500

4000

Order Quantity
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Price-Break Solution Now apply the Qopt values to total annual cost & identify the total cost for each price-break.

D Q TC = DC + S+ iC Q 2
TC(0-2499)= (10000x1.20)+(10000/1826)x4+(1826/2)(0.02x1.20) = 12,043.82 TC(2500 -3999) = 10,041 TC(4000+) = 9,949.20

Least cost Qopt = 4000

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Just-in-Time

approach to inventory management & control in which inventories are acquired & inserted in production at exact time when needed. Requirement

Chris Jarvis

Accurate production & inventory information system Highly efficient purchasing Reliable suppliers Efficient inventory-handling system

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ABC - 20/80 Principle and Inventory Control

Cumulative Percentage of Inventory Value

Items not of equal importance: invested & profit potential Sales/usage volume stock-out penalties Control expensive items closely. A items review frequently Review B & C items frequently.

100 90

70

B
A
0 15 45 Cumulative % 100

Pareto - 20/80 Principle Identify inventory items based on % of total value. A items top 20 %, B next 40 %, "C" the lower 20%.
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Annual Usage by Value

Item p3 t6 h8 j23 f45 v33 m88 s32 tt6 b88 Total

Usage p.a. 4800 3400 950 4600 9200 6400 5200 6700 7700 3250

Unit Cost 1.40 8.00 112.00 3.40 0.85 46.00 0.90 1.78 3.40 2.10

Usage 6720 26500 106400 15640 7820 294400 4680 11926 26180 6825 507,091

% of Total Usage 1.3% 5.2% 21.0% 3.1% 1.5% 58.1% 0.9% 2.4% 5.2% 1.3% 100.0%

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ABC Chart

45% 40%

Percent Usage

35% 30% 25% 20% 15% 10% 5% 0%

3 6 9 2 4 1 10 8 5 7

100% 80% 60% 40% 20% 0%

Cumulative %

Item No.

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Cumulative % Usage 41

120%

Stock Check

Book stock vs physical stock Stock valuation wastage & shrinkage Audit stock security systems Organising the stock check Internal & external audit
Segmentation of duties

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