Chapter 12. The Material Flow Cycle. The Material Flow Cycle ٠٣/٠٥/١٤٣٠. Inventory System Defined. Inventory Basics. Purposes of Inventory

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1 Chapter 12 Inventory Management The Material Flow Cycle ١ ٢ Input The Material Flow Cycle Other Wait Move Cycle Queue Setup Run Output 1 Run time: Job is at machine and being worked on 2 Setup time: Job is at the work station, and the work station is being "setup." 3 Queue time: Job is where it should be, but is not being processed because other work precedes it. 4 Move time: The time a job spends in transit 5 Wait time: When one process is finished, but the job is waiting to be moved to the next work area. 6 Other: "Just-in-case" inventory. ٣ Inventory System Defined Inventory any idle goods or materials that are held for future use, and can include: raw materials, component parts, work-in-process, finished products, and supplies. Aninventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be. ٤ Inventory Basics Inventory is created when the receipt of materials, parts, or finished goods exceeds their disbursement. Inventory is depleted when their disbursement exceeds their receipt. An inventory manager s job is to balance the advantages and disadvantages of both low and high inventories. Both have associated cost characteristics. ٥ Purposes of Inventory 1. To provide a safeguard for variation in raw material delivery time 2. To maintain independence of operations 3. To allow flexibility in production scheduling 4. To meet variation in product demand 5. To take advantage of economic purchase-order size ٦ ١

2 Inventory Costs Cost of the items: Considered when quantity discounts are offered, but in most cases it is constant Holding (or carrying) costs Costs for storage, handling, insurance, obsolescence, depreciation, taxes, tied up capital, etc Setup (or production change) costs Costs for arranging specific equipment setups, etc ing costs Costs of placing an order, etc Shortage costs Costs of canceling an order, lost goodwill/orders, late penalties, etc ٧ Opposing Views of Inventory Why We Want to Hold Inventories Why We DO Not Want to Hold Inventories ٨ Why We Want to Hold Inventories Customer Service: Reduces the potential for stockouts and backorders. ing Cost: The cost of preparing a purchase order for a supplier or a production order for the shop. Setup Cost: The cost involved in changing over a machine to produce a different item. Labor and Equipment: Creating more inventory can increase workforce productivity and facility utilization. Transportation Costs: Costs can be reduced. Quantity Discount: A drop in the price per unit ٩ when an order is sufficiently large. Why We Do Not Want to Hold Inventories Inventory holding cost all the expenses incurred because inventory is carried, and it is the sum of the cost of capital and the variable costs of keeping items on hand, such as storage and handling, taxes, insurance, and shrinkage. Cost of Capital is the opportunity cost of investing in an asset relative to the expected return on assets of similar risk. Storage and Handling arise from moving in and out of a storage facility plus the rental cost and/or opportunity cost of that space. Taxes, Insurance, and Shrinkage: More taxes are paid and insurance costs are higher if end-of-the-year inventories are high. Shrinkage comes from theft, obsolescence and deterioration. ١٠ Inventory Holding Costs (Approximate Ranges) Category Housing costs (building rent, depreciation, operating cost, taxes, insurance) Material handling costs (equipment, lease or depreciation, power, operating cost) Labor cost from extra handling Investment costs (borrowing costs, taxes, and insurance on inventory) Pilferage, scrap, and obsolescence Overall carrying cost Cost as a % of Inventory Value 6% (3-10%) 3% (1-3.5%) 3% (3-5%) 11% (6-24%) 3% (2-5%) 26% ١١ ing Costs ing costs are incurred because of the work involved in placing purchase orders with vendors or organizing for production within a plant such as: Supplies Forms processing Clerical support Etc. ١٢ ٢

3 Setup Costs Setup costs are incurred at the work station for preparing the machine and equipment for production such as: Clean-up costs Re-tooling costs Adjustment costs Etc. Inventory Problems Number of items: One or many Nature of demand: Independent or dependant; deterministic or stochastic; static or dynamic. Number of time periods in planning horizon: one or many. Lead time: deterministic or stochastic Stockouts: Backorders or lost sales. ١٣ ١٤ Three Fundamental Inventory Decisions How to monitor Inventory? How Much Should Be ed? When Should s be Placed? ١٥ Identifying Critical Inventory Items Thousands of items are held in inventory by a typical organization, but only a small % of them deserves management s closest attention and tightest control. ABC Classification: The process of dividing items into three classes, according to their dollar usage, so that managers can focus on items that have the highest dollar value. ١٦ Classifying Items as ABC ABC Classification % Annual $ Usage Class % $ Vol 100 A 80 B C 5 60 A 40 B 20 C % of Inventory Items % Items ١٧ lar value Percentage of dol Class A Class B Class C Percentage of items ١٨ ٣

4 Inventory control systems: Continuous review system: Inventory position is continuously monitored e.g. Optical scanning Two bin system Periodic review system: the inventory position is checked only at fixed intervals of time. ١٩ Inventory Accuracy and Cycle Counting Defined Inventory accuracy refers to how well the inventory records agree with physical count Cycle Counting is a physical inventory- taking technique in which inventory is counted on a frequent basis rather than once or twice a year. Used often with ABC classification Aitems counted most often (e.g., daily) ٢٠ Advantages of Cycle Counting Eliminates shutdown and interruption of production necessary for annual physical inventories Eliminates annual inventory adjustments Provides trained personnel to audit the accuracy of inventory Allows the cause of errors to be identified and remedial action to be taken Maintains accurate inventory records Techniques for Controlling Service Inventory Include: Good personnel selection, training, and discipline Tight control of incoming shipments Effective e control of all goods leaving the facility ٢١ ٢٢ Inventory Models EOQ Assumptions Fixed order-quantity models Economic order quantity Production order quantity Quantity discount Probabilistic models Fixed order-period models Help answer the inventory planning questions! Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order (setup) cost and holding cost No stockouts T/Maker Co. ٢٣ ٢٤ ٤

5 Inventory Usage Over EOQ Model How Much to? quantity = Q (maximum inventory level) Minimum inventory Inventory Le evel 0 Usage Rate Average Inventory (Q*/2) Annual Cost Minimum total cost Optimal Quantity (Q*) (Setup) Cost Curve quantity ٢٥ ٢٦ Why Holding Costs Increase More units must be stored if more are ordered Purchase Description Qty. Microwave 1 quantity Purchase Description Qty. Microwave 1000 quantity Why Costs Decrease Cost is spread over more units Example: You need 1000 microwave ovens 1 (Postage $ 0.33) 1000 s (Postage $330) Purchase Description Qty. Microwave 1000 quantity Purchase Purchase Description Purchase Description Purchase Qty. Qty. Description Description Microwave Microwave Qty. Qty. 1 1 Microwave Microwave 1 1 ٢٧ ٢٨ Deriving an EOQ 1. Develop an expression for setup or ordering costs 2. Develop an expression for holding cost 3. Set setup cost equal to holding cost 4. Solve the resulting equation for the best order quantity Optimal Quantity (Q*) Reorder Point (ROP) EOQ Model When To Lead Average Inventory (Q*/2) ٢٩ ٣٠ ٥

6 EOQ Model Equations The Reorder Point (ROP) Curve Optimal Quantity = Q* = 2 D S H Expected Number of s = N = D Q * Expected Between s D d = Working Days ROP = d L / Year Working Days / Year = T = N D = Demand per year S = Setup (order) cost per order H = Holding (carrying) cost d = Demand per day L = Lead time in days el (units) Inventory leve Q* ROP (Units) Slope = units/day = d Lead time = L (days) ٣١ ٣٢ Production Quantity Model Answers how much to order and when to order Allows partial receipt of material Other EOQ assumptions apply ppy Suited for production environment Material produced, used immediately Provides production lot size Lower holding cost than EOQ model Maximum inventory level EOQ POQ Model When To Both production and usage take place Usage only takes place ٣٣ ٣٤ POQ Model s POQ Model s Inventory level with no demand Production portion of cycle Demand portion of cycle with no supply Q* Production Portion of Cycle Max. Inventory Q (1-d/p) Supply Begins Supply Ends Supply Begins Supply Ends Demand portion of cycle with no supply ٣٥ ٣٦ ٦

7 POQ Model Equations Quantity Discount Model Optimal Quantity = Q * = p H* Maximum inventory level Setup Cost Holding Cost = D * S Q = * Q d ( 1 - p ) ( ) d = 0.5 * H * Q 1 - p 2*D*S d 1 - ( p) D = Demand per year S = Setup cost H = Holding cost d = Demand per day p = Production per day Answers how much to order & when to order Allows quantity discounts Reduced price when item is purchased in larger quantities Other EOQ assumptions apply Trade-off is between lower price & increased holding cost ٣٧ ٣٨ Quantity Discount Schedule Discount Number Discount Quantity Discount (%) Discount Price (P) 1 0 to 999 No discount $ ,000 to 1, ,000 and over 4 $ $4.75 Probabilistic Models Answer how much & when to order Allow demand to vary Follows normal distribution Other EOQ assumptions apply Consider service level & safety stock Service level = 1 - Probability of stockout Higher service level means more safety stock More safety stock means higher ROP ٣٩ ٤٠ Optimal Quantity Reorder Point (ROP) Probabilistic Models When to? Place order Frequency Lead Service Level ROP Receive order P(Stockout) SS Safety Stock (SS) X ٤١ Fixed Period Model Answers how much to order s placed at fixed intervals Inventory brought up to target amount Amount ordered varies No continuous inventory count Possibility of stockout between intervals Useful when vendors visit routinely Example: P&G representative calls every 2 weeks ٤٢ ٧

8 in a Fixed Period System Various amounts (Q i ) are ordered at regular time intervals (p) based on the quantity necessary to bring inventory up to target maximum Fixed Period Model When to? Target maximum Q 1 Q 2 Q Target maximum Q 4 On-Hand Inventory Q 3 p p p Period Period Period ٤٣ ٤٤ ٨