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INVENTORY MANAGEMENT:ABC Classification System, Cycle Counting

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Production and Operations Management ­MGT613
VU
Lesson 32
INVENTORY MANAGEMENT
Learning Objectives
Inventory Management is the procurement, use and distribution of Inventory; some text books use the
work Inventory control for the same concept. The word control ensures that inputs, the process itself and
the outputs are all manageable. This inventory control concept helps us to understand two important
concepts of Operations Management i.e. Supply Chain Management and Just In Time Production
Systems. In this lecture we will study the ABC classification System, Inventory Ordering and Holding
Costs and Economic Order Quantity Model.
Key Inventory Terms
The Key Inventory Terms we should know are Lead time, Holding (carrying) costs, Ordering ( Set
up) Costs and Shortage(Stock out) costs
1. Lead time: Time interval between ordering and receiving the order.
2. Holding (carrying) costs: Cost to carry an item in inventory for a length of time, usually a year.
Costs include Interest, insurance, taxes, depreciation, obsolescence, deterioration, pilferages,
breakage, warehousing costs and Opportunity costs. Holding (carrying) costs: Holding costs are
stated in two ways
a. Percentage of unit price or
b. Rupee
3. Ordering costs: Costs of ordering and receiving inventory. These are the actual costs that vary
with the actual placement of the order.
4.  Shortage costs: Costs when demand exceeds supply.
ABC Classification System
An important aspect of Inventory Management is that items held in inventory are not of equal
importance in terms of rupees invested, profit potential, sales or usage volume.
ABC Classification System controls inventories by dividing items into 3 groups A, B and C
respectively.
1. Group A consists of High Rupee (Monetary) Value, which account for a small portion about
10% of the total inventory usage.
2. Group B consists of Medium Rupee (Monetary) Value, which account for about 20% of the
total inventory usage.
3. Group C consists of Low Rupee (Monetary) Value, which account for a large portion about
70% of the total inventory usage.
4. The level of control reflects cost benefit concerns.
5. Group A items are reviewed on a regular basis.
6. Group B items are reviewed at a less frequency than Group A items but more than Group C
items.
7. Group C items are not reviewed and order is placed directly.
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Production and Operations Management ­MGT613
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Example.
Item
Dema
Unit
Annual
Classification
nd
Cost
Value
( Rupees)
PC
10
Rs.20,000
200,000
B ( up to Rs.
500,000)
Monitor
5
5000
25,000
C( Up to Rs.
50,000)
Processor
25
5000
125,000
B
RAM
1000
2000
2,000,000
A
Classify inventory according to ABC classification system, Rupee value up to 50K and 500K
represent C and B respectively.
Cycle Counting
1.
A physical count of items in inventory.
2.
Cycle counting management:
3.
How much accuracy is needed?
4.
When should cycle counting be performed?
5.
Who should do it?
Economic Order Quantity Models
1. Economic order quantity model
2. Economic production model
3. Quantity discount model
Assumptions of EOQ Model
1.
Only one product is involved.
2.
Annual demand requirements known.
3.
Demand is even throughout the year.
4.
Lead time does not vary.
5.
Each order is received in a single delivery.
6.
There are no quantity discounts.
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Production and Operations Management ­MGT613
VU
The Inventory Cycle
Profile of Inventory Level Over Time
Q
Usage
rate
Quantity
on hand
Reorder
point
Time
Place
Receive
Receive
Place Receive
order
order
order
order  order
Lead time
Total Cost
Annual
Annual
carrying
ordering
+
Total cost =
cost
cost
Q
D
S
H
TC =
+
2
Q
Cost Minimization Goal
Q
D
TC =
H+  S
A
2
Q
n
n
u
Holding
al
Costs
C
o
st
Ordering Costs
Order Quantity
QO(optimal order quantity)
(Q)
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Production and Operations Management ­MGT613
VU
Deriving the EOQ
Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal
to zero and solve for Q.
2DS
2(Annual Demand)(O rder or Setup Cost)
Q  OPT =
=
H
Annual Holding Cost
Minimum Total Cost
The total cost curve reaches its minimum where the carrying and ordering costs are equal.
Example 2
A local distributor for an international aerobic exercise machine manufacturer expects to sell
approximate 10,000 machines. Annual carrying cost is Rs. 2500 per machine and Order cost is Rs.
10,000. The distributor Operates 300 days a year.
1. Find EOQ?
2. The number of times the store will reorder?
3. Length of an Order Cycle?
4. Total Annual Cost if EOQ is ordered?
Given Data
D=10,000 machines.
H= Annual carrying cost is Rs. 2500 per machine.
S=Order cost is Rs. 10,000.
No of The distributor Operates 300 days a year.
Calculation of EOQ
Q0= Sq Root of (2 DS)/H=
Sq Root (2 X 10,000 X 10,000 )/2500
=Sq Root (80,000)
=283 machines per year
The number of times the store will reorder?
D/Q0=10,000/283=35.34
= 35 Times
The Length of an Order Cycle
Q0/D=283/10.000=0.0283 of a year= 0.0283 X 300= 8.49 days
The Total Annual Cost, if EOQ is ordered
TC= Carrying Cost + Ordering Cost
=Q0/2 ( H) + D/Q0 (S)
=283/2 (2500) + 10.000/283 (10,000)
=353,750 + 353,353
= Rs.  707,107
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Production and Operations Management ­MGT613
VU
Summary
Inventory Management is simply the procurement, use and distribution of Inventory. In our subsequent
discussions on Inventory as well as Supply Chain Management we will find some similarities between
the two important concepts of Inventory Management and Supply Chain Management. When we
combine Inventory Management (Control) with Production and Purchasing we are more or less focusing
on the Japanese Philosophy of Just In Time Production. Also, the basic EOQ Model minimizes the sum
of carrying or holding costs as well as setup or ordering cost.
151
Table of Contents:
  1. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT
  2. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Decision Making
  3. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Strategy
  4. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Service Delivery System
  5. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Productivity
  6. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:The Decision Process
  7. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Demand Management
  8. Roadmap to the Lecture:Fundamental Types of Forecasts, Finer Classification of Forecasts
  9. Time Series Forecasts:Techniques for Averaging, Simple Moving Average Solution
  10. The formula for the moving average is:Exponential Smoothing Model, Common Nonlinear Trends
  11. The formula for the moving average is:Major factors in design strategy
  12. The formula for the moving average is:Standardization, Mass Customization
  13. The formula for the moving average is:DESIGN STRATEGIES
  14. The formula for the moving average is:Measuring Reliability, AVAILABILITY
  15. The formula for the moving average is:Learning Objectives, Capacity Planning
  16. The formula for the moving average is:Efficiency and Utilization, Evaluating Alternatives
  17. The formula for the moving average is:Evaluating Alternatives, Financial Analysis
  18. PROCESS SELECTION:Types of Operation, Intermittent Processing
  19. PROCESS SELECTION:Basic Layout Types, Advantages of Product Layout
  20. PROCESS SELECTION:Cellular Layouts, Facilities Layouts, Importance of Layout Decisions
  21. DESIGN OF WORK SYSTEMS:Job Design, Specialization, Methods Analysis
  22. LOCATION PLANNING AND ANALYSIS:MANAGING GLOBAL OPERATIONS, Regional Factors
  23. MANAGEMENT OF QUALITY:Dimensions of Quality, Examples of Service Quality
  24. SERVICE QUALITY:Moments of Truth, Perceived Service Quality, Service Gap Analysis
  25. TOTAL QUALITY MANAGEMENT:Determinants of Quality, Responsibility for Quality
  26. TQM QUALITY:Six Sigma Team, PROCESS IMPROVEMENT
  27. QUALITY CONTROL & QUALITY ASSURANCE:INSPECTION, Control Chart
  28. ACCEPTANCE SAMPLING:CHOOSING A PLAN, CONSUMER’S AND PRODUCER’S RISK
  29. AGGREGATE PLANNING:Demand and Capacity Options
  30. AGGREGATE PLANNING:Aggregate Planning Relationships, Master Scheduling
  31. INVENTORY MANAGEMENT:Objective of Inventory Control, Inventory Counting Systems
  32. INVENTORY MANAGEMENT:ABC Classification System, Cycle Counting
  33. INVENTORY MANAGEMENT:Economic Production Quantity Assumptions
  34. INVENTORY MANAGEMENT:Independent and Dependent Demand
  35. INVENTORY MANAGEMENT:Capacity Planning, Manufacturing Resource Planning
  36. JUST IN TIME PRODUCTION SYSTEMS:Organizational and Operational Strategies
  37. JUST IN TIME PRODUCTION SYSTEMS:Operational Benefits, Kanban Formula
  38. JUST IN TIME PRODUCTION SYSTEMS:Secondary Goals, Tiered Supplier Network
  39. SUPPLY CHAIN MANAGEMENT:Logistics, Distribution Requirements Planning
  40. SUPPLY CHAIN MANAGEMENT:Supply Chain Benefits and Drawbacks
  41. SCHEDULING:High-Volume Systems, Load Chart, Hungarian Method
  42. SEQUENCING:Assumptions to Priority Rules, Scheduling Service Operations
  43. PROJECT MANAGEMENT:Project Life Cycle, Work Breakdown Structure
  44. PROJECT MANAGEMENT:Computing Algorithm, Project Crashing, Risk Management
  45. Waiting Lines:Queuing Analysis, System Characteristics, Priority Model