Costs That Are Relevant in Deciding How Much To Order Economic Order Quantity (EOQ) Formula Order Point Safety Stock Service Level
Costs That Are Relevant in Deciding How Much To Order Economic Order Quantity (EOQ) Formula Order Point Safety Stock Service Level
Costs that are relevant in deciding how much to order Economic order quantity (EOQ) formula Order point Safety stock Service level
Visual
7-1
Session 7 (cont.)
Two-bin and perpetual inventory systems The periodic review system Auditing inventory records Cycle counting process
Visual
7-2
Management has to make decision rules Methods of deciding how much to order at one time:
7-3
Lot-for-Lot
Visual
7-4
Fixed-Order Quantity
Specific amount is ordered each time an order is placed Is quick and simple Is often made on the basis of what seems reasonable Does not always produce the best results
Visual
7-5
Demand is relatively constant and known Items are produced or purchased in lots or batches Order preparation costs and inventory carrying costs are constant and known Replacement occurs all at once
Visual
7-6
Reprinted with permission, J.R. Tony Arnold, Introduction to Materials Management, 3rd edition, Prentice-Hall, 1998
Basics of Supply Chain Management, rev. 2
7-7
Order Quantity
If the order quantity (Q) increases
We want an order quantity where the sum of these two costs is a minimum.
Annual cost of ordering = Annual demand x cost of ordering Q
7-8
Reprinted with permission, J.R. Tony Arnold, Introduction to Materials Management, second edition, Prentice-Hall, 1996
Visual
7-9
Where A = Annual usage in units S = Ordering cost in dollars i = Annual inventory carrying cost as a decimal c = Unit cost
Basics of Supply Chain Management, rev. 2
Visual
2AS EOQ = ic
7-10
7-11
Problem 7.1
A S i c = = = = 100,000 units $32 per order 20% = .20 $8 per unit
2AS EOQ = ic
Basics of Supply Chain Management, rev. 2
Visual
7-12
2AS EOQ = ic
What can be controlled
7-13
If an order is placed late, there is the possibility of a stockout. If an order is placed early, there will be extra inventory and cost. A system is needed to tell when to order. Common systems include
Order point system Periodic review system Master scheduling
Visual
7-14
Visual
7-15
7-16
Order Point
Order quantities are usually fixed Order point is determined by the average demand during the lead time Intervals between replenishments are not constant Average inventory Order point = Demand during lead time + safety stock
Order quantity Average inventory = + safety stock 2
Visual
7-17
Problem 7.2
The lead time for a particular SKU is four weeks, the average demand is 200 units per week, and safety stock is set at one weeks demand. The order quantity is 2,000 units. Calculate the order point.
Visual
7-18
Safety Stock
Safety stock is used to prevent a stockout. The amount of safety stock carried depends on
Variability of demand during the lead time Frequency of ordering Desired service level Length of the lead time Ability to forecast and control lead times
Visual
7-19
Service Levels
The cost of carrying safety stock plus the cost of a stockout should be a minimum Costs of a stockout:
Cost of backorder Cost of lost sales Cost of lost customers
All are difficult to calculate Management should state the number of stockouts per year that is tolerable
Visual
7-20
Two-bin system
Perpetual inventory record system
Visual
7-21
Issued
400
Visual
7-22
Figure reprinted with permission, J.R. Tony Arnold, Introduction to Materials Management, second edition, Prentice-Hall, 1996 Basics of Supply Chain Management, rev. 2
Visual
7-23
7-24
Visual
7-25
There are many small issues from inventory, and posting transactions is expensive Many different items are ordered from one source Ordering costs are small
Visual
7-26
Problem 7.3
T = = = D (R + L) + SS
Order quantity = = =
TI
Visual
7-27
Periodic, usually annual, counts of all items Cycle, usually daily, counts of selected items
Visual
7-28
Primary purpose is to verify the financial value of the inventory Production is disrupted while inventory takes place Labor and paperwork are expensive Accuracy is poor
People taking the inventory are usually inexperienced and error prone
Visual
7-29
Cycle Counting
Inventory is counted continually throughout the year Some items are counted each day All items are counted a predetermined number of times a year depending on their importance Cycle counting uses trained and dedicated personnel
Visual
7-30
Cycle Counting
Purpose: To identify items in error and eliminate causes of error Advantages
Timely detection and correction of problems Little or no loss of production Identification and elimination of causes of error
Visual
7-31
Visual
7-32
Count Frequency 12 4 2
Visual
7-33
Problem 7.4
Count Frequency 12 4 2
Number of Counts
250
Visual
7-34
Session 7: Objectives
Understand the costs that are relevant in deciding how much to order at one time Explain the assumptions used in deriving the economic order quantity and calculate an economic order quantity using the standard EOQ formula Explain the concept of an order point Understand the reasons for carrying safety stock
Visual
7-35
Session 7: Objectives
Describe the idea of service level and the factors influencing it Explain the two-bin system and the perpetual inventory system Understand the use of the periodic review system Recognize the purpose of auditing inventory records Explain the cycle counting process
Visual
7-36
Problem 7.5
A S i c = = = =
EOQ = 2AS 2 x 12,000 units x $20 = = 506 units ic .25 x $7.50
Visual
7-37
Problem 7.5
A S i c = 12,000 units = $20 = 25% = .25 = $7.50
EOQ = 2AS 2 x 12,000 units x $20 = = 506 units ic .25 x $7.50
Annual demand 12,000 Orders per year = = = 23.7 Order quantity 506
Basics of Supply Chain Management, rev. 2
Visual
7-37a
Problem 7.6
Target level = D (R + L) + SS = Order quantity =
Visual
7-38
Problem 7.7
Classification Number of Items Count Frequency Number of Counts
Visual
7-39