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Midterm Lecture Note

AMA International
University
College of administrative
and Financial Science
Subject:-
Management Science 2
AI-!"#
Prepared by: Abdulaziz Al-Saadi
http://amaiu.pbwiki.com
aziz.alsaadi@gmail.com
Cotact !umber "#$%&$%&
INVENTORY MANAGEMENT

INVENTORY MANAGEMENT
What to Inventory?
(A) Raw materials and purchased parts
(B) Partially completed goods
(C) Finished-goods inventories or merchandise
(D) Replacement parts, tools, and suppliers
(E) oods-in-transit to warehouses or oods In progress
!ypes o" #emand$
%& Dependent Demand
These are items that are typically subassemblies or component parts that will be
used in the production of a final or finished product. Subassemblies and
component a part is derived from the number of finished units that will be
produced. Example: Demand for wheels for new cars.
'& Independent Demand
These are items that are the finished goods or other end items. These items are
sold or at least shipped out rather than used in making another product.
Functions o" Inventory
%( To meet anticipated customer demand( These inventories are referred to as
anticipation stocks because they are held to satisfy planned or expected demand.
'( To smooth production requirements( Firms that experience seasonal patterns in
demand often build up inventories during offseason to meet overly high re!uirements
during certain seasonal periods. "ompanies that process fresh fruits and vegetable
deal with seasonal inventories
)( To decouple operations. The buffers permit other operations to continue temporarily
while the problem is resolved. Firms have used buffers of raw materials to insulate
production from disruptions in deliveries from suppliers# and finished goods inventory
to buffer sales operations from manufacturing disruptions.
*( To protect against stock-outs. Delayed deliveries and unexpected increases in
demand increase the risk of shortages. The risk of shortages can be reduced by
holding safety stocks# which are stocks in excess of anticipated demand.
+( To take advantage of order cycles( $nventory storage enables a firm to buy and
produce in economic lot si%es without having to try to match purchases or production
with demand re!uirements in short run.
,( To hedge against price increase( The ability to store extra goods also allows a firm to
take advantage of price discounts for large orders.
-( To permit operations( &roduction operations take a certain amount of time means that
there will generally be some workinprocess inventory.
'aagemet Sciece-( Page ( o) *" Abdulziz Al-saadi
'idterm !otes
Inventory is a stock or store of goods. $t includes raw materials or stock incoming suppliers.

Inade.uate control o" inventories
$nade!uate control of inventories can result into two categories:
%& /nder stoc0ing results in missed deliveries, lost sales, dissatis"ied customers and
production 1ottlenec0s(
'& 2verstoc0ing unnecessarily ties up "unds that might 1e more productive
!wo Main 3oncerns o" Inventory Management
First "oncern 'evel of customer service to have the right goods# in sufficient !uantities# in
the right place# and at the right time# second "ost of ordering and carrying inventories.
214ectives o" Inventory Management
To achieve satisfactory levels of customer service while keeping inventory costs within
reasonable bounds. 5peci"ically Decision maker tries to achieve a balance in stocking and
Fundamental decision must be made related to the timing and si%e of orders
Re.uirements "or 6""ective Inventory Management
To be effective# management must have the following:
%( 7 system to 0eep trac0 o" the inventory on the hand on order(
'( 7 relia1le "orecast o" demand that includes an indication o" possi1le "orecast error(
)( 8nowledge o" lead times and lead time varia1ility(
*( Reasona1le estimates o" inventory holding costs, ordering costs, and shortage costs(
+( 7 classi"ication system "or inventory items(
Inventory 3ounting 5ystems
%& Periodic 5ystem
This is a physical count of items in inventory is made at periodic intervals (e.g. weekly#
monthly) in order to decide how much to order of each item. Ma4or users$ Supermarkets#
discounts stores# and department stores.
Advantage
*rders for many items occur at the same time# which can result in economies in processing
and shipping orders
Disadvantages
a) 'ack of control between reviews.
b) The need to protect against shortages between review periods by carrying extra stock.
c) The need to make a decision on order !uantities at each review
'aagemet Sciece-( Page " o) *" Abdulziz Al-saadi
'idterm !otes

'& Perpetual Inventory 5ystem (also known as a continual system)
This keeps track of removals from inventory on a continuous basis# so the system can provide
information on the current level of inventory for each item.
Advantages
+. The control provided by the continuous monitoring of inventory withdrawals.
,. The fixedorder !uantity- management can identify an economic order si%e.
Disadvantage
+. The added cost of record keeping.
!wo-1in-system method
$s two containers of inventory- reorder when the first is empty. The advantage of this system
is that there is no need to record each withdrawal from inventory- the disadvantage is that the
reorder card may not be turned in for a variety of reasons.
!rac0ing 5ystem
/niversal Product 3ode 9/P3& bar code printed on a label that has information about the
item to which it is attached. .ar coding represents an important development for other sectors
of business besides retailing. $n manufacturing# bar codes attached to parts# subassemblies#
and finished goods greatly facilitate counting and monitoring activities.
#emand Forecast and Lead time In"ormation
/anagers need to know the extent to which demand and lead time might vary- the greater
the potential variability# the greater the need for additional stock to reduce the risk of a
shortage between deliveries.
Inventory 3ost 9Three Basic Costs)
+. :olding or 3arrying 3ost is the costs to carry an item in inventory for a length of
time usually a year. "ost includes interest# insurance# taxes# depreciation#
obsolescence# deterioration# spoilage# pilferage# breakage# etc.
,. 2rdering 3ost is cost of ordering and receiving inventory. These include determining
how much is needed# preparing invoices# inspecting goods upon arrival for !uality and
!uantity# and moving the goods to temporary storage.
0. 5torage 3ost is cost resulting when demand exceeds the supply of inventory on hand.
These costs can include the opportunity cost of not making a sale# loss of customer
goodwill# late charges# and similar costs
'aagemet Sciece-( Page & o) *" Abdulziz Al-saadi
'idterm !otes
Lead time is time interval between ordering and receiving the order.

Inventory Management 3ontinue;(
3lassi"ication 5ystem
1n important aspect of inventory management is that items held in inventory are not of e!ual
importance in terms of dollars invested# profit potential# sales or usage volume# or stockout
penalties. Example: 1 producer of electrical e!uipment might have electric generators# coils
of wire# and miscellaneous nuts and bolts among the items carried in inventory. $t would be
unrealistic to devote e!ual attention to each of these items.
7-<-3 7pproach
1." 1pproach classifies inventory items according to some measure of importance# usually
annual dollar usage# and then allocates control efforts accordingly.
!he 0ey .uestions concerning cycle counting "or management are$
+. 2ow much accuracy is needed3
,. 4hen should cycle counting be performed3
0. 4ho should do it3
632N2MI3 2R#6R =/7N!I!> M2#6L5
6conomic 2rder =uantity 962=& is the order si%e that minimi%es total cost. 62= models
identify the optimal order !uantity in terms of minimi%ing the sum of certain annual costs that
vary with order si%e.
!hree 9)& 2rder 5i?e
+. The economic order !uantity model.
,. The economic order !uantity model with non instantaneous delivery.
0. The !uantity discount model.
Inventory 3ycles 1egins with the receipt o" an order o" = units, which are withdrawn at
instant rate over time( When the .uantity on the hand is 4ust su""icient to satis"y demand
during lead time, an order "or = units is su1mitted to the supplier(
'aagemet Sciece-( Page + o) *" Abdulziz Al-saadi
'idterm !otes
!hree 3lasses o" Items /sed$
7 9very important&
< 9moderately important&
3 9least important&

#eveloping 62= Mathematical Model
7ssumption o" the <asic 62= Model
%( 2nly one product is involved(
'( 7nnual demand re.uirements are 0nown(
)( #emand is spread evenly throughout the year so that the demand rate is
reasona1ly constant(
*( Lead time does not vary(
+( 6ach order is received in a single delivery(
,( !here are .uantity discounts(
Order Quantity Order Quantity
Annual Cost Annual Cost
Holding Cost Holding Cost
EOQ Model
Order Quantity Order Quantity
Annual Cost Annual Cost
Holding Cost Holding Cost
Order (Setup) Cost Order (Setup) Cost
EOQ Model
Order Quantity Order Quantity
Annual Cost Annual Cost
Holding Cost Holding Cost
Total Cost Curve Total Cost Curve
Order (Setup) Cost Order (Setup) Cost
Optimal Optimal
Order Quantity (Q*) Order Quantity (Q*)
EOQ Model
'aagemet Sciece-( Page # o) *" Abdulziz Al-saadi
'idterm !otes
Holding Cost(H) or carrying cost
relate to ha,ig items i storage. Cost
icludes iterest- isurace- ta.-
depreciatio /bsolesce- deterioratio-
spoilage- breakage. 0arehouse cost
1heat- light- security ad ret.
2 3/4 'odel 5oldig Cost is
3.press i terms o) uit- So:
!otal holding 3ost @
Num1er o" unit A .uantity
rdering Costs are the costs o)
orderig ad recei,ig i,etory.
6hey are the cost that ,aries with the
actual placemet o) a order such as
shippig cost- preparig i,oices-
ispectig goods upo arri,als.
!he ordering 3ost eApress as FiAed
dollars per order regardless o"
order si?e.
7y mergig the two 8raphs we ca
otice that the miimum 2,etory
Cost is at the itersectio poit.
!otal 3ost @
:olding 3ost B 2rdering 3ost

*ptimal 5uantity 6
1nnual 2olding "ost 6
5
4
.
,
1nnual "arrying "ost 6
S
4
9
.
Total annual $nventory "ost6
5
4
.
,
7
S
4
9
.
'ength *f order "ycle 6
.
9
4
6C7MPL6 2F 2R#6RIN 325! F73!2R5
&rocessing and inspecting incoming inventory
Developing and sending purchase orders
.ill paying
$nventory in!uiries
8tilities# phone bills# and so on# for the purchasing department
Salaries and wages for the purchasing department employees
Supplies such as forms and paper for the purchasing department
6C7MPL65 2F 37RR>IN 325! F73!2R5
"ost of capital
Taxes
$nsurance
Spoilage
Theft
*bsolescence
Supplies such as forms and paper for the warehouse
8tilities and building costs for the warehouse
Salaries and wages for warehouse employees
#eterminants o" Reorder point .uantity 1whe we ha,e to reorder:;
a& Rate o" demand
1& !he lead time
c& !he eAtent o" demand
d& !he degree o" stoc0 out ris0 accepta1le to management
'aagemet Sciece-( Page $ o) *" Abdulziz Al-saadi
'idterm !otes
5
S 9
3/4

=
,
R2P 9Reorder Point& @ #aily #emand C Lead !ime
R2P @ d A L
!ote that Demand is on daily "asis

6Aample
Save/art needs +999 coffee makers per year. The cost of each coffee maker is :;<.
*rdering cost is :+99 per order. "arrying cost is :,9 of per unit cost. 'ead time is =
days. Save/art is open 0>9 days?yr.
(A) 4hat is E*5 /odel3
(B) 2ow many times per year does the store reorder3
(C) 4hat is the length of order cycle3
(D) 4hat is the total annual cost if the E*5 !uantity is ordered3
7nswer

(1) 5
4
5
S 9
3/4 .
, +9
+99 +999 , ,
=

=

= 6 +99 units
(.) @umber of orders 6
.
4
9
6
.
+99
+999
6 +9 times
(") "ycle 'ength 6
.
9
4
6
.
+999
+99
6 9.+ per year 6 9.+ x 0>9 days?year 6 0> days
(D) Total 1nnual $nventory "ost 6
5
4
.
,
7
S
4
9
.
6
+99
+99
+999
,9 .
,
+99
. . +
6,999
62= with Non instantaneous Replenishment 96P=&
'aagemet Sciece-( Page < o) *" Abdulziz Al-saadi
'idterm !otes

When a "irm is 1oth a producer and a user or deliveries are spread over time,
inventories tend to 1uild up gradually instead o" instantaneously. $f usage production
(or delivery) rates are e!ual# there will be no inventory buildup since all output will be
used immediately and the issue of lot si%e doesnAt come up. $n the more typical case# the
production or delivery rate exceeds the usage rate. $n the production case# production
occurs over only a portion of each cycle because the production rate is greater than the
usage rate# and usage occurs over the entire cycle.
The economic &roduction 5uantity 6
u p
p
5
9S

.
,
!otal Inventory cost @ 3arrying cost B setup cost
S
4
9
5
2
6C . .
,
max
min
+ =
3ycle !ime @
u
4
p
time 1etween 1eginning o" range
Run time @
p
4
p
production phase of the cycle
1verage inventory
,
max
2
2
a,erage
=
!he maAimum inventory level @
) .( u p
p
4
p

Where
P is Production or #elivery Rate
/ is usage rate
6Aample
'aagemet Sciece-( Page = o) *" Abdulziz Al-saadi
'idterm !otes

1 toy manufacturer uses B<#999 rubber wheels per year for its popular dump truck. The firm
makes its own wheels# which it can produce at a rate of <99 per day. The toy trucks are assembled
uniformly over entire year. "arrying cost is : + per wheel a year. Setup cost of production run of
wheels is :B=. The firm operates ,B9 days per year. Determine the:
a) *ptimal Cun Si%e.
b) /inimum total annual cost for carrying and setup.
c) "ycle time for the optimum run si%e.
d) Cun time.
7nswer
D 6 B<#999 wheels per year
S6 : B=
26 : + per wheel per year
& 6 <99 wheels per day
8 6 B<#999 wheel per ,B9 days or ,99 wheels per day
a) 5
p
6
u p
p
5
9S

.
,
6
,99 <99
<99
.
+
B= ) B<999 ( ,

6,B99 wheels
b)
S
4
9
5
2
6C . .
,
max
min
+ =
so we first must find $
max
The maximum inventory level @
) .( u p
p
4
p

6 wheel +<99 ) ,99 <99 .(


<99
,B99
=
So
S
4
9
5
2
6C . .
,
max
min
+ =
6 +<99 ) B= (
,99
B<99
) + (
,
+<99
= +
c) 3ycle !ime @ days
u
4
p
+,
,99
,B99
= =
d) Run time @
days
p
4
p
0
<99
,B99
= =

62= with =uantity #iscount
=uantity #iscounts are price reductions "or large orders o""ered to customers to induce
them to 1uy in large .uantities( $f !uantity discounts are offered# the customer must weigh the
'aagemet Sciece-( Page *% o) *" Abdulziz Al-saadi
'idterm !otes

potential benefits of reduced purchase price and fewer orders that will result from buying in large
!uantities against the increase in carrying costs caused by higher average inventories
!3 @ carrying cost B 2rdering cost B Purchasing 3ost
!3 @
. . .
,
P9 S
4
9
5
4
+ +
Where$ P @ /nit price
EXAMPLE
The maintenance department of a large hospital uses about +<9 cases of li!uid cleanser
annually. *rdering costs are :,=# carrying costs are := per case a year# and the new
schedule indicates that orders of less than B= cases will cost :,.9 per case# B= to >D will
cost :+.; per case# and more than ;9 cases will cost :+.B per case. Determine the optimal
order !uantity and total cost.
uit
5
S 9
3/4 B0
=
,= +<9 , ,
=

=

=
Total "ost 6 5
4
.
,
7
S
4
9
.
6 += . ,D< B0 , ,=
B0
+<9
= .
,
B0
= + + . . .
$f we order B= unit we may get discount the price will be reduced from :, to :+.; and the
total annual cost will be:
Total 1nnual "ost 6 5
4
.
,
7
S
4
9
.
6 = . =+< +<9 ; . + ,=
B=
+<9
= .
,
B=
= + + . . .
$f we order ;9 unit we may get further reduction as the price will be reduced from :+.; to
:+.B the annual cost in this case would be :
Total 1nnual "ost 6 5
4
.
,
7
S
4
9
.
6 0 . BD+ +<9 B . + ,=
;9
+<9
= .
,
;9
= + + . . .
4e can note that at some range from B= to ;9 units annual cost will be appropriate even the E*5
state other range due to discount effect.
Pro1lemD%
1 local distributor for a national tires company expects to sells approximately D>99 steel
belted radial tires of certain si%e and treated design next year. 1nnual carrying cost is :+> per
tire and ordering cost is : ;=. The distributor operates ,<< days a year.
'aagemet Sciece-( Page ** o) *" Abdulziz Al-saadi
'idterm !otes

(A) 4hat is E*5 /odel3
(B) 2ow many times per year does the store reorder3
(C) 4hat is the length of order cycle3
(D) 4hat is the total annual cost if the E*5 !uantity is ordered3
Pro1lemD'
1 large bakery buys flour in ,=pound bags. The bakery uses an average ofE B#<>9 bags a
year. &reparing an order and receiving a shipment of flour involves a cost of :+9 per order.
1nnual carrying costs are :;= per bag.
(A) Determine the economic order !uantity.
(B) 4hat is the average number of bags on hand3
(C) 2ow many orders per year will there be3
(D) "ompute the total cost of ordering and carrying flour.
(E) $f ordering costs were to increase by :+ per order# how much that would affect the
minimum total annual cost3
Pro1lemD)
1 large law firm uses an average of B9 boxes of copier paper a day. The firm operates ,>9
days a year. Storage and handling costs for the paper are :09 a year per box# and its costs
approximate : >9 to order and receive a shipment of paper.
(A) 4hat order si%e would minimi%e the sum of annual ordering and carrying costs3
(B) "ompute the total annual cost using your order si%e from part a3
(C) Except for rounding# are annual ordering and carrying costs always e!ual at E*53
(D) The office manager is currently using an order si%e of ,99 boxes. The partners of the
firm expect the office to be managed Fin a costefficient manner.F 4ould you
recommend that the office manages use the optimal order si%e instead of ,99 boxes3
Gustify your answer.
Pro1lemD*
2ighland Electric "o. buys coal from "edar "reek "oal "o. to generate electricity.
"""" can supply coal at the rate of 0#=99 tons per day for :+9.=9 per ton. 2E" uses the
coal at a rate of <99 tons per day and operates 0>= days per year. 2E"As annual carrying
cost for coal is :, per ton# and the ordering cost is :=#999.
a) 4hat is the economical production lot si%e3
b) 4hat is 2E"As maximum inventory level for coal3
c) 4hat is "ycle time and run time for the optimum run si%e.

Pro1lemD+
The friendly Sausage factory (FSF) can produce hot dogs at a rate of =#999 units per day.
FSF supplied hot dogs to local restaurant at a steady state rate of ,=9 per day. The cost to
'aagemet Sciece-( Page *( o) *" Abdulziz Al-saadi
'idterm !otes

prepare e!uipment for producing hot dog is :>>. 1nnual holding cost is B= cents per hot
dog. The factory operates 099 days a year. Find
a) The optimal run si%e.
b) The number of runs per year.
c) The length (in days) of a run.
Pro1lemD,
1 chemical firm produces sodium bisulphate in +99pound bags. Demand for this product
is ,9 tons per day. The capacity for producing the product is =9 tons per day. Setup cost
:+99 and storage and handling cost are := per ton a year. The firm operates ,99 days a
year. (@ote + ton 6 ,999 pounds)
a) 2ow many bags per run are optimal3
b) 4hat would the average inventory be for this lot si%e3
c) Determine the approximate length of a production run in days3
d) 1bout how many runs per year would there be3
e) 2ow much could the company save annually if the setup cost reduced to :,= per
run3
Pro1lemD-
1 mail order house uses +<#999 boxes a year. "arrying cost are >9 cent of a box cost price and
ordering cost are :D> per order. The following price schedule applied. Determine:
a) The optimal order !uantity3
b) The number of orders per year3
Num1er o" 1oAes &rice per box
%EEE to %FEE : +.,=
'EEE to *FFF : +.,9
+EEE to FFFF : +.+=
%EEEE or more :+.+9

'aagemet Sciece-( Page *" o) *" Abdulziz Al-saadi
'idterm !otes