INVENTORY CONTROL MODELS – EOQ & JIT

BY:EHSAN UL HAQSWATI MEHTASAGAR GUPTA

AAKASH GUPTA

WHAT IS INVENTORY?

• The term inventory originates from the French word ‘Inventaire’ & Latin word ‘Inventariom’, which implies a list of things found.

• An asset not participating in conversion or not getting sold

• A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state.– Raw Materials– Works-in-Process – Finished Goods– Maintenance, Repair and Operating (MRO)

THUS, INVENTORY MANAGEMENT INVOLVES ADMINISTRATION, POLICIES & PROCEDURES TO REDUCE IN INVENTORY COST.

OBJECTIVES OF INVENTORY MANAGEMENT

• Ensure a continuous supply raw materials & supplies to facilitate uninterrupted production.

• Maintain sufficient-finished goods for smooth sales operation & efficient customer service.

• Inventory management helps to reduce material handling costs.

• Reduce dependencies of one another & enable, the organizations to schedule its operations independently of another.

• It helps to utilize people & equipment reasonably.• It facilitates product display & service to customers

INVENTORY RELATED COSTS

• Procurement Costs - management and staff time, order preparation and dispatch, follow up, transport from vendor, receiving, handling storage

• Carrying Costs - capital, opportunity, space, tax, security, insurance, spoilage and preservation, obsolescence

• Out of stock costs - emergency transport, lost sale, lost customer

TYPE OF INVENTORY

• Location inventory- Inventory at a fixed location

• In transit inventory[pipeline inventory]-Being transported and or waiting to be transported

• Manufacturing Inventory- Raw material

components, Work-In-Progress, Finished Good, MRO [Maintenance, repairs and operating supplies]

METHODS OF INVENTORY MANAGEMENT

• ABC (Always better control) classification• VED (Vital, essential & desirable)classification• HML (High, Medium & low)classification• FSN (Fast moving, slow moving & not moving)• EOQ (Economic Order Quantity)• JIT (Just In Time)

ABC ANALYSIS• The most widely technique of controlling inventory

is ABC(Always Better Control) analysis.• The objective of ABC control is to vary the

expenses associated with maintaining appropriate control according to the potential savings associated with a proper level of such control.

• ABC analysis divides inventory into 3 categories A, B & C based on their annual consumption value.

• It is often called the Selective Inventory Control Method (SIM).

Procedure For ABC Analysis

1. List each item carried in inventory by number or some other designation.

2. Determine the annual volume of usage & rupee value of each item.

3. Multiply each item’s annual volume of usage by its rupee value.4. Compute each item’s percentage of the total inventory in terms of

annual usage in rupees.5. Select the top 10 per cent of all items which have the highest

rupee percentages & classify them as ‘A’ items.6. Select the next 20 per cent of all items with the next highest rupee

percentages & designate them ‘B’ items.7. The next 70 per cent of all items are ‘C’ items.

HML ANALYSIS

• It follows the same procedure as ABC analysis.• Only difference is that HML classification unit

value is the criterion & not the annual consumption value.

• The items of inventory are to be listed in descending order of unit value.

• This analysis is useful for keeping control over consumption at departmental levels, for deciding frequency of physical verification and for controlling purchases.

VED ANALYSIS

• The VED analysis is done to determine the criticality of an item & its effect on production & other services, especially in case of spare parts.

• If a part is vital, it is given ‘V’ classification, if it is essential, then it is given ‘E’ classification & if it is not so essential, the part is given ‘D’ classification.

• For ‘V’ items, a large stock of inventory is generally maintained, while for ‘D’ items minimum stock is enough.

SDE ANALYSIS• The SDE analysis is based upon the availability of items & is very

useful in the context of scarcity of supply.

• In this analysis, ‘S’ refers to ‘scarce’ items, generally imported, and those which are in short supply ‘D’ refers to difficult items which are available indigenously but are difficult items to procure. Items which have to come from distant places or for which reliable suppliers are difficult to come by, fall into ‘D’ category. ‘E’ refers to items which are easy to require & are available in local market.

• This analysis is based on problems faced in procurement, is vital to lead time analysis & in deciding on purchasing strategies.

FSN ANALYSIS

• FSN stand for fast moving, slow moving & not moving. Here, classification is based on pattern of issues from stores & is useful in controlling obsolescence.

• To carry out FSN analysis, the date of receipt or the last date of issue, whichever is later, is taken to determine the number of months which have lapsed since the last transaction. The items are usually grouped in periods of 12 months.

• FSN analysis is helpful in identifying active items which need to be reviewed regularly & surplus items which have to be examined further. Non-moving items may be examined further & their disposal can be considered.

EOQ MODELWhat should be the size of the order?

Small orders result in: – low inventory levels & carrying costs – frequent orders & higher ordering costs

Large orders result in: – higher inventory levels & carrying costs – infrequent orders & lower ordering costs

EOQ is the technique which solves the problem of the manager. EOQ or Opt Q is the order quantity at which the total cost , comprising ordering cost plus carrying cost is the least.

Assumptions of Wilson’s Lot size formula or Classical EOQ model

1. Demand is at a known constant rate and uniform throughout the period

2. Lead time is known and constant3. Demand is fully satisfied, no shortages are

allowed4. All costs are time invariant(no back orders are

allowed)5. Quantity discounts are not considered.6. Price per unit of product is constant.7. No constraints are imposed on quantities

ordered, storage capacity, budget etc.

Inventory Cycle• The assumptions of the EOQ model yield the saw-

toothed inventory pattern.• The vertical lines at the 0, T1 & T2 points in time

represent the instantaneous replenishment of the item by the amount of the order quantity, Q, and the negatively sloped lines between the replenishment points represent the use of the item.

• Because the inventory level varies between 0 and the order quantity, average inventory is equal to one-half of the order quantity, or Q/2.

Inventory Cycle

0 T1 T2

AVERAGE INVENTORY= Q/2

Q

GRAPHIC SOLUTION

EOQ

TOTAL COST

CARRYINGCOST (Q/2) Ch

Order Quantity Size Q

Cost

ORDERING COST D/Q Co

GRAPHIC SOLUTION

• An examination of the 2 curves reveals that the carrying cost curve is linear i.e., the more the inventory held in any period, greater will be the cost of holding it.

• Ordering cost curve, on the hand, is different. Ordering in small quantities means more acquisition & higher ordering costs. The ordering costs decrease with increase in order sizes.

• A point where the carrying cost curve & the ordering cost curve meet represent the least total cost which incidentally is Economic Order Quantity or optimum quantity.

ALGEBRAIC SOLUTION• We know,Total Annual cost = Annual Purchase cost + Annual Ordering cost + Annual Holding cost TC = DC + D/Q Co + Q/2 Ch

Where, TC= TOTAL COST D= ANNUAL DEMAND C= PURCHASE COST / UNIT Q= QUANTITY TO BE ORDERED (Q optimum = EOQ)

Co = ORDERING/SETUP COSTS

Ch = COST OF HOLDING ONE UNIT OF INVENTORY

• For the cost to be minimum, cost of ordering is equal to the cost of carrying, or D/Q Co = Q/2 Ch

Which in turn is solved as, D Co = Q² / 2 Ch or 2 D Co = Q² Ch or Q² = 2 D Co / Ch

Thus,

Q (optimum) or EOQ = 2 D Co / Ch

ALGEBRAIC SOLUTION

• Thus, algebraic form of EOQ or Optimal Quantity can be defined as:

• Q = 2DCo/Ch

D = annual demand

Co = ordering/setup costs

Ch = cost of holding one unit of inventory

EXAMPLE: An auto industry purchases spark plugs at the rate of Rs. 25 per piece. The annual consumption of spark plug is 18,000 units. If the ordering cost is Rs. 250 per order and carrying cost is 25% p. a. What would be the EOQ? SOL: Calculation of EOQ:

Annual demand (D) = 18000 units Unit price (P) = Rs.25 Ordering cost per order (C0) = Rs.250 Carrying charges in % = 25% p. a.Carrying charges per unit (Ch) = Rs 25 * .25 = Rs 6.25

EOQ = 2 *D *C0 Ch

= 2*18000*250 6.25 = 1200 units.

LIMITATIONS

JUST IN TIME

• Just-In-Time(JIT) is defined in “ a philosophy of manufacturing based on planned elimination of all waste and on continuous improvement of productivity”

• It also has been described as an approach with the objective of producing the right part in the right place at the right time (in other words, “Just In Time”)

• JIT seeks to increase an organization’s ability to compete with others and remain competitive over the long run.

• Increasing efficiency within the production process. Efficiency is obtained through the increase of productivity and decrease of cost.

• Reducing wasted materials, time and effort. It can help to reduce the costs.

HISTORY OF JIT

• The technique was first used by the Ford Motor company during 1920s.

• But the technique was subsequently adopted and publicized by Toyota Motor Corporation of Japan as part of its Toyota production System(TPS).

• In 1954 Japanese giant Toyota implemented this concept in order to reduce wasteful overstocking in car production.

• It was developed and perfected by Taiichi Ohno of Toyota, who is now referred to as the father of JIT.

• Taiichi Ohno developed this philosophy as a means of meeting customer demands with minimum delays.

KEY ELEMENTS OF JIT

• Uniform Plant loading

• Reduce or eliminate setup times

• Reduce lot sizes (manufacturing and purchase)

• Reduce lead time (production and delivery)

• Preventive maintenance

• Flexible work force

• Require supplier quality assurance and implement a zero defects quality program

• Small-lot (single unit)

GOALS OF JIT

1. Estimation of non-value added activities

2. Zero inventory

3. Batch size of one

4. A 100% on time delivery service.

BENEFITS OF JIT1. Reduced set up times

2. Improved flows of goods

3. Employees who possess multi-skills are utilized more efficiently.

4. Better consistency of scheduling and consistency of employee work hours.

5. Increased emphasis on supplier relationships.

6. Supplies continue around the clock keeping workers productive and businesses focused on turnover.

The main benefit of JIT is that it can improve production efficiency and therefore competitiveness.

DRAWBACKS FOR JIT IN INDIA

Drawbacks

Cultural differences Other problems Loss of autonomy

Production level/employee skills

Implem-entation

Traditionalapproach

Benefits may vary

Individual Team Method

COMPANIES THAT HAVE IMPLEMENTED JIT

CONCLUSION