BEM 241: Inventory management - How much to order

ABC classification system

An inventory classification system in which a small percentage of (A) items account for most of the inventory value. each class of inventory requires different levels of inventory monitoring and control—the higher the value of the inventory, the tighter the control.

Which of the following is not true regarding the EOQ model? A. As the order size increases, the average inventory increases. B. As the order size increases, the annual ordering cost increases. C. As the order size increases, the number of orders per year decrease. D. As the order size increases, the annual carrying cost increases. E. All of the above are true regarding the basic EOQ model.

B

inventory

a stock of items kept by an organization to meet internal or external customer demand

two versions of EOQ

basic EOQ Production Quantity Model

three costs of inventory

carrying or holding costs ordering costs shortage costs

basic EOQ

formula for determining the optimal order size that minimizes the sum of carrying costs and ordering costs.

demand

starting point for inventory management dependent demand independent demand

a continuous (or fixed‐order‐quantity) system

A constant amount is ordered when inventory declines to a predetermined level. The order that is placed is for a fixed amount that minimizes the total inventory costs. advantage: inventory level is constantly monitored disadvantage: can be costly

Which of the following is not an assumption associated with the basic EOQ model? A. Demand is known with certainty. B. Demand is constant. C. Shortages are allowed. D. Leadtime for the receipt of replenishment orders is constant. E. All of the above are assumptions associated with the basic EOQ model.

C

In the basic EOQ model, that average inventory can be calculated by A. Subtracting the order quantity from the maximum inventory level. B. Adding the order quantity to the maximum inventory level. C. Dividing the order quantity by the maximum inventory level. D. Dividing the order size by 2. E. Dividing the maximum inventory by the order size.

D

assumptions of basic EOQ

Demand is known with certainty and is constant over time. No shortages are allowed. Lead time for the receipt of orders is constant. The order quantity is received all at once.

Which of the following is not a reason to hold inventory? A. To provide customers with high service levels. B. To guard against unexpectedly high demand. C. As protection against late shipments from suppliers. D. The smooth out needed capacity. E. All of the above are reasons for holding inventory.

E

Which of the following is true in situations where a supplier offers a quantity discount? A. The basic EOQ model will still provide the optimal order quantity. B. The Economic Production Quantity model should be used. C. If the EOQ model yields an order quantity in the highest priced unit cost category, then this order quantity is optimal. D. To find the optimal order quantity, the order quantity found using the EOQ formula should be compared to all price breaks both above the EOQ and below it. E. To find the optimal order quantity, the order quantity found using the EOQ formula should be compared to all price breaks that provide a lower unit cost.

E

two types of inventory systems

a continuous (or fixed‐order‐quantity) system a periodic (or fixed‐time‐period) system.

production quantity model

also referred to as the gradual usage and non‐instantaneous receipt model. •Order is received gradually, as inventory is simultaneously being depleted •non-instantaneous receipt model •assumption that Q is received all at once is relaxed p - daily rate at which an order is received over time, the production rate d - daily rate at which inventory is demanded

inventory system

controls the level of inventory by determining how much to order (the level of replenishment) and when to order.

ordering costs

costs associated with replenishing the stock of inventory being held as the order size increases, ordering costs decrease and carrying costs increase.

objective of inventory management

employ an inventory control system that will indicate how much should be ordered and when orders should take place so that the sum of the three inventory costs just described will be minimized.

quantity discounts

is a price discount on an item if predetermined numbers of units are ordered. Price per unit decreases as order quantity increases

independent demand

items are final or finished products that are not a function of, or dependent on, internal production activity

dependent demand

items are typically component parts or materials used in the process of producing a final product.

shortage costs

referred to as stockout costs, occur when customer demand cannot be met because of insufficient inventory If these shortages result in a permanent loss of sales, shortage costs include the loss of profits. as the amount of inventory on hand increases, the carrying cost increases, whereas shortage costs decrease.

carrying or holding costs

the costs of holding items in inventory. the greater the level of inventory over a period of time, the higher the carrying costs examples: Facility storage (rent, depreciation, power, heat, cooling, lighting, security, refrigeration, taxes, insurance, etc.) Material handling (equipment) Product deterioration, spoilage, breakage, obsolescence, pilferage

Periodic inventory system

the inventory on hand is counted at specific time intervals—for example, every week or at the end of each month. In this system, the inventory level is not monitored at all during the time interval between orders, so it has the advantage of little or no required record keeping. The disadvantage is less direct control.

purpose of inventory management

to determine the amount of inventory to keep in stock—how much to order and when to replenish, or order.

optimal order quantity

where the total cost curve is at a minimum, which coincides exactly with the point where the carrying cost curve intersects the ordering cost curve

why carry inventory

•Bullwhip effect - demand information is distorted as it moves away from the end-use customer - safety stock inventories are stored to compensate •Seasonal or cyclical demand •Inventory provides independence from suppliers •Inventory provides independence between stages and avoids work stoppages •Take advantage of price discounts

Approach for Determining Order Quantity when Quantity Discounts are Offered

•Calculate Qopt using the EOQ formula ignoring the quantity discounts •If Qopt qualifies for the lowest unit price, use Qopt for the order size •If Qopt does not qualify for the lowest unit price, compare Qopt and all price-break quantities that qualify for lower unit cost in terms of total annual cost •Select order quantity that provides the lowest total annual cost

demand and production rate

The demand rate cannot exceed the production rate, since we are still assuming that no shortages are possible if d = p, there is no order size, since items are used as fast as they are produced the production rate must exceed the demand rate p ≥ d.

Economic order quantity

The optimal order quantity that will minimize total inventory costs. used in a continuous system

order cycle

The time between receipt of orders in an inventory cycle