INVENTORY MANAGEMENT

INVENTORY--- A physical resource that a firm

holds in stock with intent of selling it or
transforming it into more valuable state.
INVENTORY SYSTEMS---
A set of policies that determines what levels should
be maintained, when the stock should be
replenished, and how large the orders should be.

1
 INVENTORY MANAGEMENT
• Inventory is needed for the definite consumption of
materials, and to take care of the uncertainty
involved in the usage or availability of the material.
• The inventory taking care of the first aspect of
normal consumption is called the normal inventory
& the inventory taking care of the second aspect of
uncertainty is called the safety or buffer stock of
inventory

2
 REASONS FOR INVENTORIES
• Improve customer service
• Economies of Purchasing
• Economies of Production
• Uncertainty in lead time.
• Transportation savings
• Hedge against future.( Uncertainty of Demand)
• Price increase.
• Inventory covers up problem.
3
OBJECTIVES OF INVENTORY
• Maximum customer service.
• Low cost plant operations.
• Minimum inventory investments.

4
 INVENTORY
• Types of inventory---
• Raw material
• Work in progress
• Finished goods
• Classification of inventory---
• Anticipation inventory
• Fluctuation inventory
• Lot size inventory
• Transportation inventory
5
 INVENTORY COSTS
• Item cost– it is the price paid for a purchased price,
which consists of the cost of the item & any other
direct costs associated in getting the item in the
plant.These could include cost of transportation ,
custom duties , insurance etc.
• The inclusive cost is often called as LANDED
PRICE.

7
 INVENTORY COSTS
• INVENTORY CARRYING COSTS.—This is
expressed as fraction of value of goods stocked
every year.
• Cost of incurring shortages.
• Storage costs ( Space,workers & equipment)
• Cost due to obsolescence
• Capital ( Interest rate)
• Pilferage , damage.
• Cost of insurance.
• Deterioration. 8
 INVENTORY CARRYING COSTS
• A company carries an average annual inventory of
Rs.20,00,000. If they estimate the cost of capital is
10%, storage costs are 7%,& risk costs are 6%,what
does it costs per year to carry this inventory?
• Total cost of carrying inventory = 10% + 7% +6% =
23%.
• Annual cost of carrying inventory =0.23 * 20,00,000
= 4,60,000.

9
 INVENTORY COSTS
• ORDERING COST—This is also called as cost of
acquisition.This is basically the expenditure for
placement of the order & further activities in
company such as receiving,inspection, binning etc.
• Purchase cost.—Higher is the qty. , more is the
bargaining power in terms of qty. discount.
• Set-up & Ordering cost.– Costs associated with
frequent set-up changes at vendor & with expense
associated with each purchase ,salaries & overhead
in purchase dept.
10
 ORDERING COSTS
• Given the following annual costs, calculate the
average cost of placing one order.
• Production control salaries = Rs. 60,000.
• Supplies & operating expenses for production
control department = 15,000.
• Cost of setting up work centers for an order = 120
• Orders placed each year = 2000.
• Average cost = fixed cost / no. of orders + variable
cost.
• = 60,000 + 15000 / 2000 + 120 = Rs. 157.50. 11
 INVENTORY COSTS
Behavior of Two Distinct Cost

Carrying cost Order cost

80 TOTAL INVENTORY
60 COST
Cost

INVENTORY
40 E.O.Q. CARRYING COST
20
ORDERING COST
0
1 2 3 4 5
Average Level of Inventory
12
 INVENTORY MANAGEMENT
• Re-Order Point: When Quantity on hand of a item
drops to this level, item is reordered.
• Safety Stock: Stock that is held in excess of
expected demand due to variable demand rate and/or
lead time.It is intended to protect against uncertainty
in supply & demand. ( Qty. uncertainty-SS & timing
uncertainty—safety lead time )
• Service Level: Probability that demand will not
exceed supply during lead time.

13
 Order quantity

Average
inventory

Reorder point
INVENTORY
QUANTITY

Lead time in
quantity

Safety stock
TIME Lead time w.r.t.
Time factor
14
 INVENTORY CALCULATIONS
• LET
• D = Annual Demand=yearly usage of items.
• Q = Procurement Quantity per order = number of
items ordered in each replenishment period( E.O.Q.)
• O = Order Cost Per Order.
• p = Price of an item.
• i = Rate of interest charged per unit per year.
• ip = Capital Cost
• H = Additional Holding cost, if any.
• C = Total annual inventory cost.
15
 INVENTORY CALCULATIONS
• Total Inventory Cost = Annual ordering cost +
Annual Inventory Carrying Cost.
• Ordering Cost = Cost per order * number of units
demanded per year / number of units per order i.e.=
O * D / Q.
• Annual Carrying Cost = ( Holding cost + interest
charge per unit per year) * Average inventory i.e. =
( H + ip ) * Q/2.
• Total Inventory Cost = O * D / Q + ( H + ip ) * Q/2

16
 INVENTORY CALCULATIONS
• Q= 2 O D / H+ip

• No. Of orders to place in year = D / Q

• Order interval = t = No. of working days in a year /
D/Q
• Total Annual Stocking Cost = OD/Q + (H+ip) Q/2+
PD.
• Average inventory = Q/2+ Safety stock
• Order point(OP) = Demand during lead time
(DDLT) + Safety Stock (SS) 17
 ASSUMPTIONS
• Assumptions on which EOQ formula is based are as
follows—
• Demand is relatively constant & is known.
• The item is produced or purchased in lots or batches
& not continuously.
• Order preparation cost & inventory carrying costs
are constant & known.

18
 EXAMPLE
• A manufacturer uses Rs 10000 worth of an item
during the year. He has estimated the ordering cost
as Rs 25 per order & carrying cost as 12.5 % of
average inventory value. Find the order size, no. of
orders per year, time period per order & total cost.
• Q = 2 OD / H + ip = 2 * 25 * 10000 / 0.125
= 2000 (Rs)
•No. Of Orders = D / Q = 10000 / 2000 = 5
•Order Interval = No of working Days / (D / Q)
= 300 / 5 = 60
19
•Total Cost = OD/Q + (H+ip)*Q/2 = 125+125=250
 EXAMPLE
• The annual demand is 10,000 units,the ordering cost
is Rs. 30 per order, the carrying cost is 20% & the
unit cost is Rs. 15. The order quantity is 600
units.Calculate Annual ordering cost , Annual
carrying cost & Total annual cost.
• D = 10,000 UNITS.
• O = Rs. 30
• i= 0.20
• P = Rs. 15
• Q = 600 units
20
 EXAMPLE
• Annual ordering cost = O*D /Q= 10,000/600*Rs. 30
= Rs. 500
• Annual carrying cost = Q / 2 * i*P=600/2*0.2*Rs.15
= Rs. 900
• Total cost = Rs.500 + Rs. 900 = Rs. 1400.

21
 EXAMPLE
• The annual demand for an item is 10,075 units & it
is ordered in quantities of 650 units. Calculate
average inventory & no. of orders placed per year.
• Average inventory = order quantity / 2 = 650 / 2 =
325 units.
• Number of orders per year = Annual demand / order
quantity. = 10075 / 650 = 15.5 = 16.

22
 EXAMPLE
• Demand is 200 units a week, the lead time is three
weeks, & safety stock is 300 units. Calculate the
order point.
• OP( Ordering Point ) = DDLT ( Demand During
Lead Time ) + SS (Safety Stock )
• = 200 * 3 + 300
• = 900 UNITS.
• If Annual demand is 12000 units & Lead Time is 20
Days, Calculate DDLT considering 300 working
days –
• = (12000 / 300) * 20 = 800 23
 EXAMPLE
• Order quantity is 1000 units & safety stock is 300
units. What is the average annual inventory ?
• Average inventory = Q / 2 + Safety Stock
• = 1000 / 2 + 300
• = 800 units.

24
 Price Discount Model
• An item has an annual demand of 25,000 units.
Every unit costs Rs.10.Order preparation cost is
Rs.10 & carrying cost is 20 %. It is ordered on basis
of an EOQ,but the supplier has offered a discount of
2% on orders of Rs. 10,000 or more. Should the
order be accepted ?
• Q = 2 O * D / i*P = 2*10*25,000 /(0+ 0.20 * 10)
• = 500 UNITS
• = 500 * Rs. 10 = Rs. 5000.
• Discounted order qty.= Rs. 10,000*0.98 = Rs. 9,800.
25
 INVENTORY CALCULATIONS
Cost Particulars No Discount With Discount

O ( Rs)

D (Units)
Ordering
Cost Q (Units)
(A)
O*D / Q

H + i*p
Inventory
Carrying Q/2
Cost
(B) (H+i*p) * Q/2

Purchase Cost Unit Cost *

(C) Annual
Consumption
Total Cost A+B+C
26
 INVENTORY CALCULATIONS
Cost Particulars No Discount With Discount

O 10 10

D 25000 25000
Ordering
Cost Q 500 1000
(A)
OD/Q 10*25000/500 = 500 10*25000/1000 = 250

i *P 0.2 * 10 = 2 0.2 * 9.8 = 1.96

Inventory
Carrying Q/2 250 500
Cost
(B) (i*P)* (Q/2) 2 * 250 = 500 1.96 * 500 = 980

Purchase Cost Unit Cost * 10 * 25000 = 2,50,000 9.8 * 25000 = 2,45,000

(C) Annual
Consumption
Total Cost A+B+C 500 + 500 + 2,50,000 = 250 + 980 + 2,45,000 =
2,51,000/- 2,46,230 27
 FINANCIAL INVENTORY
PERFORMANCE MEASURES
• Inventory is an asset & represents money that is tied
up & can not be used for any other purpose.Lesser
the inventory,better it is.Total inventory is one
measure which does not relate to sales.
• Two measures that do relate to sales are inventory
turnover ratio & days of supply.
• Inventory turnover ratio = annual sales / average
inventory. ( unit of measurement is either qty. or
money. )
• Days of supply = inventory on hand / av.daily usage
28
 EXAMPLE PROBLEMS
• Calculate inventory turnover ratio if annual sales (
Cost of good sold ) is Rs. 2,40,00,000 & average
inventory is Rs.60,00,000.
• Inventory turns = annual cost of good sold / average
inventory. = 2,40,00,000 / 60,00,000 = 4.
• What would be reduction in inventory if inventory
turns were increased to 12 times a year.
• Average inventory = annual cost of good sold /
inventory turns = 2,40,00,000 / 12 = 20,00,000.
• Reduction in inventory = 60,00,000 – 20,00,000=
40,00,000.
29
 EXAMPLE PROBLEMS
• If the cost of carrying the inventory is 25 % of the
average inventory , what will be the savings ?
• Reduction in inventory = 40,00,000
• Savings = 40,00,000 * 0.25 = 10,00,000.
• A company has 9000 units on hand & the annual
usage is 48,000 units.There are 240 working days in
the year. What is the days of supply?
• Average daily usage = 48,000 / 240 = 200 units.
• Days of supply = inventory on hand / average daily
usage = 9000 / 200 = 45 days. 30
 PROBABILISTIC INVENTORY
MODELS
• In the inventory models described earlier,we
assumed that there was no uncertainty associated
with demand & lead times. However in reality there
is always some uncertainty associated with demand
& lead times. Extra buffer stock is required to
account for these uncertainties. This extra stock will
be added to the expected demand during lead times ,
to obtain reorder point. There will still be probability
of stock out even after carrying this extra buffer
stock.
31
 Normal Distribution
• These characteristics are summarized in the graph.

32
Normal Distribution

33
 PROBABILISTIC INVENTORY
MODELS
• From statistics , we can determine that
• The actual demand will be within +/- 1 sigma of the
forecast average approximately 68 % of the time ,
+/- 2 sigma 95 % of the time & +/- 3 sigma 99.88%
of the time.
• One property of the normal curve is that it is
symmetrical about the average. This means that half
the time the actual demand is less than the average
& half the time it is greater.
34
 PROBABILISTIC INVENTORY
MODELS
• Safety stocks are needed to cover only those periods
in which the demand during the lead time is greater
than the average. Thus the service level of 50% can
be attained without any safety stock.
• Suppose the std.dev. of Demand During Lead Time
is 100 units & this amount is carried out as safety
stock. This safety stock is able to provide protection
for 84% of time.
• The service level is a statement of percentage of
time there is no stock out.
35
 PROBABILISTIC INVENTORY
MODELS
• The service level is directly related to the number of
std. Deviations provided as safety stock & is usually
called the SAFETY FACTOR.
TABLE OF SAFETY FACTOR

SERVICE LEVEL ( % ) SAFETY FACTOR

50 0
75 0.67
80 0.84
85 1.04
90 1.28
94 1.56
95 1.65
96 1.75
97 1.88
98 2.05
99 2.33
99.86 3 36
99.99 4
 PROBABILISTIC INVENTORY
MODELS--EXAMPLE
• SIGMA IS 200 UNITS.--- Calculate the safety stock
& order point for an 84% service level. ( DDLT =
1000)
• If a safety stock equal to two std. Deviations is
carried, calculate the safety stock & the order point.
• A) Safety stock = 1 sigma = 1 * 200 = 200 units.
• Order point = DDLT + SS =1000 + 200 =1200 units.
• B) SS = 2 * 200 = 400 UNITS.
• OP = DDLT + SS = 1000 + 400 = 1400 UNITS.
37
 PROBABILISTIC INVENTORY
MODELS--EXAMPLE
• If the Std. Dev.is 200 units ,what safety stock should
be carried to provide a service level of 90% ?If the
expected demand during the lead time is 1500
units,what is the order point ?
• The safety factor for a service level of 90% is 1.28.
• Safety stock = sigma * safety factor = 200 * 1.28 =
256 units.
• Order point = DDLT + SS = 1500 + 256 = 1756
units.
38
 PROBABILISTIC INVENTORY
MODELS--EXAMPLE
• Suppose management of a company decides that
only one stock-out in a year is allowed for a specific
item. For this particular item , the annual demand is
52,000 units. It is ordered in quantities of 2600, &
Std. Dev. of demand during the lead time is 100
units. The lead time is one week. Calculate :
• Number of orders per year.
• Service level
• Safety stock.
• Order point. 39
 PROBABILISTIC INVENTORY
MODELS--EXAMPLE
• Number of orders per year = annual demand / order
quantity. = 52,000 / 2600 = 20 times a year.
• Since one stock out per year is tolerable, there must
be no stock outs 19 ( 20-1 ) times a year.
• Service level % = (20-1 / 20)*100 = 95 %
• From table – safety factor = 1.65
• Safety stock=safety factor*sigma=1.65*100=165uts.
• Demand during lead time = (1 week)
(52,000)/52=1000 units.
• OP = DDLT + SS = 1000+ 165 = 1165 units. 40
 PERIOD ORDER QUANTITY
• The POQ uses the EOQ formula to calculate an
economic time between orders. This is calculated by
dividing the EOQ by demand rate. This produces
time interval for which orders are placed. Instead of
ordering same quantity (EOQ) , orders are placed to
satisfy requirements for the calculated time interval.
The no. of orders placed in a year are same as for
EOQ, but the amount ordered each time varies. Thus
ordering cost is same . Because the order quantities
are determined by actual demand , the carrying cost
is reduced. POQ = EOQ / Av. Periodic Usage 41
 EXAMPLE
• Given is MRP record & an EOQ of 250
units,calculate the planned order receipts using the
EOQ. Next, calculate the POQ & planned order
receipts. In both cases, calculate the ending
inventory & the total inventory carried over the ten
weeks.

WEEK 1 2 3 4 5 6 7 8 9 10 TOTAL
NET REQUIREMENTS 100 50 150 75 200 55 80 150 30 890
42
 EOQ = 250 Units, Weekly Average Demand = Units
POQ:

Week 1 2 3 4 5 6 7 8 9 10 Total

Net 100 50 150 0 75 200 55 80 150 30 890

Requirement

Planned
Order
Receipts

Ending
Inventory

Closing Stock / Ending Inventory = , No of orders = , 43

Ordered Qty =
 EOQ = 250 Units, Weekly Average Demand = 890 / 10 = 89 Units
POQ: 250 / 89 = 2.81 ~ 3 Weeks

Week 1 2 3 4 5 6 7 8 9 10 Total

Net 100 50 150 0 75 200 55 80 150 30 890

Requirement

Planned 300 ---- ---- --- 330 ---- --- 260 --- ---- 890 (
Order 3
Receipts Time
s)
Ending 200 150 0 0 255 55 0 180 30 0
Inventory

Closing Stock / Ending Inventory = 0, No of orders =3 , 44

Ordered Qty = 890
 Economic Production Quantity Model
or Economic Batch Size Model
• Batch production---
• How to determine the optimum batch size ? ---
• D= Demand in units per year
• P= Production rate in terms of units per year.
• A = set up cost per batch size of Q.
• C= Unit variable cost of production per piece.
• i = annual inventory carrying cost rate
• h = inventory carrying cost per unit per year.
• Q = Square root of 2 A D / i C ( 1 – D / P ) 45
 PRODUCTION PLANNING &
CONTROL
• Example---
• Monthly Demand = 2000
• Daily production rate = 100
• Cost of set up = 6000
• Cost of holding inventory = Rs. 10 per unit per year
• Calculate EBQ.

46
 PRODUCTION PLANNING &
CONTROL
Example
Monthly demand = 2000
Daily production rate = 100
Cost of setup = 6000
Cost of holding inventory = Rs. 10 per unit per year
Annual demand = 2000 * 12 = 24000
Consumption rate = 2000/ 25 = 80

EBQ =  (2* 6000* 24000) / 10 [(100 – 80) / 100]

= 12000 units.
47
 ABC ANALYSIS
• ABC analysis is a basic analytical management tool
which enables top management to place the efforts
where the results will be greatest.
• Always Better Control.
• The technique tries to analyze distribution of any
characteristic by money value of importance in order
to determine it’s priority.
• The analysis does not depend upon unit cost of the
items but only on it’s annual consumption value.
48
 ABC ANALYSIS
• ABC analysis enables the material manager to
exercise selective control when he is handling with
very large number of items.
• Tighter & accurate controls are required for ‘A’
value items .
• The degree of control should be rigorous for ‘A’
items & should be minimum for ‘C’ items.

49
 ABC ANALYSIS
• METHOD OF ABC ANALYSIS—
• Calculate annual consumption of each item. i.e.Unit
cost * annual consumption.
• Prepare the list of all items showing item no., unit
cost,annual consumption value etc.
• Sort all items in descending order.
• Compute a running total .
• Compute percentage.

50
 ABC ANALYSIS
• Normally top 5% to 10 % items contribute 70 %
of value.—’A’ items.
• Next 15 % to 20 % items contribute 20 % of total
consumption value----’B’ items.
• The remaining no. of items account for balance 15
% of the total consumption value.----’C’ items.

• The results of ABC analysis have to be

periodically reviewed & updated.
51
 ABC ANALYSIS
A items B items C items
1 Very strict control Moderate control Loose control
2 Very low stocks Low stocks High stocks
Once in fortnight / Once in month / two /
3 Frequent ordering month threee months.
Daily control Monthly control Quarterly control
4 statements statements statements
Maximm follow-up & Follow-up in exceptional
5 expediting Periodic follow-up. cases.
Rigorous value Moderate value
6 analysis. analysis. Minimum value analysis.
Accurate forecast in Estimates based on
7 material planning past data. Rough estimates.
Maximum efforts to
8 reduce lead time Moderate Minimum.
Highest priority for
minimisation of waste,
obsolescence & 52
9 surplus. Moderate Minimum.
 ABC ANALYSIS
PART NO. UNIT USAGE UNIT COST ANNUAL USAGE

1 1100 2 2200

2 600 40 24000

3 100 4 400

4 1300 1 1300

5 100 60 6000

6 10 25 250

7 100 2 200

8 1500 2 3000

9 200 2 400

10 500 1 500
53
TOTAL 5510 38250
 ABC ANALYSIS
PART NO. ANNUAL USAGE CUMULATIVE USAGE CUMULATIVE % USAGE CLASS
2 24000 24000 62.75 A

5 6000 30000 78.43 A

8 3000 33000 86.27 B

1 2200 35200 92.03 B

4 1300 36500 95.42 B

10 500 37000 96.73 C

9 400 37400 97.78 C

3 400 37800 98.82 C

6 250 38050 99.48 C

54
7 200 38250 100 C
CUMULATIVE % OF USAGE ABC ANALYISIS

120
100

80
60
40

20
0
1 2 3 4 5 6 7 8 9 10
Series1 62.75 78.43 86.27 92.03 95.42 96.73 97.78 98.82 99.48 100
Series2 10 20 30 40 50 60 70 80 90 100
CUMULATIVE % OF ITEMS

55
 ANALYSIS OF INVENTORY
• VED Analysis –
• Guidelines for ABC are to be used along with
individual industry norms & with V.E.D. analysis.
Some items ,though negligible in monetary value,
may be vital for running of the plant & constant
attention is needed.
• XYZ Analysis
• FSN Analysis

56
VED analysis
Nuisance value of materials is cost associated with material due to their
absence. If, these materials are not available they hold up production &
therefore, there are high cost of shut down or slow-down of production.
The investment in these materials may be small but for lack of any of
them, the production process may come to grinding halt. These are
critical items, which are required in adequate quantity.
VED stands for Vital items, which have extreme criticality,
Desirable items are not that critical & Essential items are somewhere
In between. VED ranking can be done on the basis of the shortage cost
of materials, which can be either quantified or qualitatively expressed.

XYZ
Sometimes the bulk versus weight of the materials is of importance in
terms of providing space for the materials in the stores & therefore
another XYZ classification such as 1) Bulky 2) Medium bulky
57
3) Not bulky may also be of interest.
HML (high, moderate, lower) Basis – unit price of material
Use – mainly control purchases

FSN – Materials can be classifies on the rate of movement of the

materials in the stores; fast moving, slow moving & non-moving.
The non-moving items can be in such cases listed & the list be sent to
the different department which might be interested in these materials to
ascertain whether they still desire storing of these materials in the stores.
The items, which have become obsolete, can be sold off, some time
it raises huge amount of salvage value.

SDE – Base – Problem in procure

Scarce – Difficult – Easy
Use – Lead time analysis, Purchasing strategies

GOLF (Govt., Local, Foreign source)

Base – Source
Use – Purchase strategies 58
 PRICING OF INVENTORY
• LIFO
• FIFO
• WEIGHTED AVERAGE METHOD

59
 EXAMPLE
MATERIAL - COTTON YARN UNIT - KILOS

DATE TRANSACTION QTY. RATE VALUE

1/8/2004 BALANCE 500 2 1000

3/8/2004 ISSUE 300

6/8/2004 PURCHASE 800 2.2 1760

8/8/2004 ISSUE 400

12/8/2004 ISSUE 300

14/8/04 PURCHASE 400 2.5 1000

20/8/04 ISSUE 600

24/8/04 PURCHASE 500 2.8 1400

25/8/04 ISSUE 300

28/8/04 ISSUE 100

60
FIFO

DATE PURCHASE ISSUE BALANCE

QTY. RATE VALUE QTY. RATE VALUE QTY. RATE VALUE

1/8/2004 500 2.00 1000

3/8/2004 300 2.00 600

6/8/2004 800 2.20 1760 200 2.00

800 2.20 2160
8/8/2004 200 2.00
200 2.20 840 600 2.20 1320
12/8/2004

14/8/04

20/8/04

24/8/04

25/8/04

28/8/04

VALUE OF CONSUMPTION --
61
VALUE OF CLOSING STOCK
LIFO

DATE PURCHASE ISSUE BALANCE

QTY. RATE VALUE QTY. RATE VALUE QTY. RATE VALUE

1/8/2004 500 2.00 1000

3/8/2004 300 2.00 600

6/8/2004 800 2.20 1760 200 2.00

800 2.20 2160
8/8/2004 400 2.20 880 200 2.00
400 2.20 1280
12/8/2004 300 2.20 660 200 2.00
100 2.20 620
14/8/04

20/8/04

24/8/04

25/8/04

28/8/04

VALUE OF CONSUMPTION --
62
VALUE OF CLOSING STOCK
WEIGHTED AVERAGE RATE:--
QTY—500 KGS. @ 2.00 RS. & QTY.—800 @ 2.20 RS
THEREFORE W.A.R.= 500 * 2.00 + 800 * 2.20 / (500 + 800)
= 2.12

63
 WEIGHTED AVERAGE RATE
DATE PURCHASE ISSUE BALANCE
QTY. RATE VALUE QTY. RATE VALUE QTY RATE VALUE

1/8/2004 500 2.00 1000

3/8/2004 300 2.00 600 200 2.00 400

6/8/2004 800 2.20 1760 1000 2.12 2120

8/4/04 400 2.12 848 600 2.12 1272

12/8/2004 300 2.12 636 300 2.12 636

14/8/04

20/8/04

24/8/04

25/8/04

28/8/04

VALUE OF COSUMPTION
64
VALUE OF STOCK
 MRP :--
One product consists of many items. If we know production plan,
we come to know requirement of raw materials.
It is better to depend on this than statistics & probabilities.
It is simple method of calculating requirement based on production plan.
This system works well for items that do not have direct demand
but have derived demand.
Pre-requisites of system :--
1) COMPUTERIZATION
2) Suitable for dependent demand situation
3) Demand derived from MPS & Lead-time
4) Firm schedule for final product
5) Efficient information feedback system
Handling uncertainties of MRP-
Safety stock: One cannot do away the safety stock concept. Continue
MRP & EOQ to handle uncertainties

65
66
Materials Requirements
Planning

67
 OBJECTIVES

• Material Requirements Planning (MRP)

• MRP Logic and Product Structure Trees
• Time Fences
• MRP Example
• MRP II and Lot Sizing

68
Material Requirements Planning
Defined
• Materials requirements planning (MRP) is a
means for determining the number of parts,
components, and materials needed to produce
a product
• MRP provides time scheduling information
specifying when each of the materials, parts,
and components should be ordered or
produced
• Dependent demand drives MRP
• MRP is a software system
69
 Example of MRP Logic and Product
Structure Tree
Given the product structure tree for “A” and the lead time and
demand information below, provide a materials requirements
plan that defines the number of units of each component and
when they will be needed
Product Structure Tree for Assembly A Lead Times
A 1 day
A B 2 days
C 1 day
D 3 days
E 4 days
B(4) C(2) F 1 day

Total Unit Demand

Day 10 50 A
D(2) E(1) D(3) F(2) Day 8 20 B (Spares)
Day 6 15 D (Spares)
70
 First, the number of units of “A” are scheduled
backwards to allow for their lead time. So, in the
materials requirement plan below, we have to place
an order for 50 units of “A” on the 9th day to receive
them on day 10.

Day: 1 2 3 4 5 6 7 8 9 10
A Required 50
Order Placement 50

LT = 1 day

71
 Next, we need to start scheduling the components that make up
“A”. In the case of component “B” we need 4 B’s for each A.
Since we need 50 A’s, that means 200 B’s. And again, we back
the schedule up for the necessary 2 days of lead time.
Day: 1 2 3 4 5 6 7 8 9 10
A R e q u ire d 50
O rd e r P la c e m e n t 50
B R e q u ire d 20 200
O rd e r P la c e m e n t 20 200

LT = 2
Spares
A 4x50=200

B(4) C(2)

D(2) E(1) D(3) F(2) 72

 73
Finally, repeating the process for all components, we have the
final materials requirements plan:
Day: 1 2 3 4 5 6 7 8 9 10
A Required 50
LT=1 Order Placement 50
B Required 20 200
LT=2 Order Placement 20 200
C Required 100
LT=1 Order Placement 100
D Required 55 400 300
LT=3 Order Placement 55 400 300
E Required 20 200
LT=4 Order Placement 20 200
F Required 200
LT=1 Order Placement 200

A
Part D: Day 6
B(4) C(2) 40 + 15 spares

D(2) E(1) D(3) F(2) 73

©The McGraw-Hill Companies, Inc., 2001