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Transcript of Application of Inventory Model in Industry - Foong Weng Kang - TS160.F66 2008
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ABSTRACT
This study discusses the inventory models used at Ngee Ming Shoe Manufacturer
Sdn. Bhd, Selangor. The objective of the study is to identify and analyze the most
appropriate inventory models to be used in the company in term to decide the
ordering quantity and ordering time interval. The data gathered from interviews,
observations, journals, books, internet and company inventory record. The result was
analyzed, there are three inventory models used to determine the ordering quantity
and ordering interval time; Economic Order Quantity (EOQ), Economic Production
Quantity (EPQ) and Quantity Discount (QD). Each model has different
characteristic, where EOQ is focus on inventory cost, EPQ is focus on the production
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ABSTRAK
Kajian ini membincangkan tentang penggunaan model inventori di Syarikat Ngee
Ming Sdn. Bhd, Selangor. Objektif utama kajian ini adalah untuk menentukan dan
menganalisis model inventori yang paling sesuai dilaksanakan dalam syarikat
tersebut untuk menentukan kuantiti dan kekerapan pesanan. Data diperolehi daripada
temuduga, permerhatian, buku, jurnal, laman web dan data inventori syarikat.
Selepas data dianalisis, tiga model inventori digunakan bagi menentukan kuantiti dan
kekerapan pesanan iaitu kuantiti pesanan ekonomi, pengeluaran kuantiti ekonomi
dan kuantiti diskaun. Setiap model inventori mempunyai kriteria yang berbeza,
dimana kuantiti pesanan ekonomi menfokus kepada kos-kos penyimpanan,
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CHAPTER 1
INTRODUCTION
1.1 Company Background
Ngee Ming Shoe Manufacturers Sdn. Bhd. has successfully developed a complete
range of industrial safety shoe suitable for various working conditions. The company
has been specialized in providing steel toe, safety footwear for thousands of
hardworking people throughout Malaysia. They produce a wide range of products
named Oscar Safety Shoes and they manufactured by ISO 9001:2000 accredited
facilities and adhere to international quality standards.
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1.3 Objectives
There are several study objectives;
a) To identify the most appropriate inventory model to apply into the
company.
b) To protect against uncertainties such as supply, demand and lead time, so
safety stocks are required.
c) To allow economic production and purchase, it is more economic to
produce materials in a lot size because it can reduce the ordering costs,
quantity costs and transportation costs.
d) To ensure the company has gain customers satisfactory and competitive
advantages.
e) To ensure the products have delivered before due date and avoid loss
sales due to stock out.
1.4 Scope
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1.5 Important of The Project
The project is to determine the ordering quantity and timing in a minimum cost. This
project is important because with a suitable inventory model applied can succeed the
business operation and supply chain. A good inventory model can also reduce the
capital cost where the company can manage the buying amount without the problem
of exceed inventory. The capital can be invested in other investment to gain higher
turnover. Therefore, the turnover ratio is increased. Besides that, it can give more
empty spaces in the warehouse for other purposes. The capital can be invested in
other investment where have higher turnover.
The appropriate ordering time and quantity is important to ensure the company have
sufficient shoes supply to the customer during the production lead time. This is to
avoid the problems of delaying in products delivery time to customer where it may
caused the customer to switch to another supplier. Therefore, the company has loss in
sales and customer satisfactory. The company reputation will also drop and it is hard
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CHAPTER 2
LITERATURE REVIEW
2.1 Definition of Inventory
Inventory is stock or store of goods (Stevenson, 2007). In manufacturing, inventory
consists of raw materials, work-in-process, and finished goods. In wholesaling and
retailing, inventory is the stock of merchandise on hand. In direct marketing,
inventory may refer to direct-mail package components that are available for mailing
when needed. In the broadcast and print media industry, inventory is the time or
space available for sale to advertisers. In magazine publishing, inventory is the
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A firm can typically stock many of items in inventory. Thus, manufacturing firm
carry supplies of raw materials, purchased parts, partially finished item and finished
goods. Inventories may represent a significant portion of total assets, a reduction of
inventories can result in a significant increase in return on investment (ROI).
However, many of items have a limited life time, so carrying large quantities would
mean having to dispose of unused, costly supplies.
Another consideration has been take is the space requirements of inventory. Space
limitation may pose restrictions on inventory storage capability, more space can
increase the storage capability thus more item can stored but also increase the
inventory holding costs. So it is depend on the functions of inventory. The most
important functions are to meet anticipated customer demand, to smooth production
requirement, to decouple operations, to protect against stock outs, to take advantage
of order cycles, to hedge against price increases, to permit operations and take
advantage of quantity discounts.
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In the software era Gordon Graham paved the road for today's inventory
management consultants. Gordon managed a consulting and training company for
over 25 years. Gordon spent many years consulting with distributors on how to
implement quality inventory management practices. Business practices that are easily
understood and which provide proven results on the distributors bottom line profits
(Gordon Graham, 1990).
Charles Bodenstab views order history as an inventory management database and
brings to it the power of statistical analysis. Charles Bodenstab's involvement during
the 1950's and 1960's with developing some of the earliest qualitative automated
approaches to inventory management. Charles has said
much of the statisticaltheory built into automated inventory control systems completely ignored the day-to-
day business realities of the typical distributor .
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2.2.2 Inventory Management Techniques
2.2.2.1 Demand Forecasting
Basically, inventory control needs to order the items some time before the customers
demand them, it is because the lead time between the ordering time and the delivery
time and also due to certain ordering costs it is often necessary to order in batches
instead of unit for unit. That s the forecasting need t o look ahead and forecast the
future demand. A demand forecast is estimated average of the demand size over
some future period. If the forecast is not certain, more safety stock is required.
Table 2.1: Forecasting techniques and formulation
Technique Formula Definitions
Moving average
forecast
Ft =( ! A t-i)/n A = Demand in period t-1
N = number of periods
Exponential smoothing Ft = F t-1 + (A t-1 F t-1) = smoothing factor
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Linear regression
forecast
yc = a + bc
b = (n( ! xy) (! x)( ! y)) /
(n(! x2) (! x)2)
a = ( ! y - b! x)/n
yc = computed value of
dependent variable
x = predictor
(independent) variable
b = slope of the line
a = value of y c when x=0
2.2.2.2 Material Requirement Planning
Material Requirement Planning (MRP) is a computer based information system that
translates master schedule requirements for end item into time-phased requirementsfor subassemblies, components, and raw material. The backward from the due date
using the lead time to determine the time and quantity of the order. An MRP system
is intended to simultaneously meet 3 objectives:
a) Ensure materials and products are available for production and delivery to
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expected to receive by the beginning and receipt offset by lead time. Basically, the
net requirement can determine by eliminate the gross requirement by available
inventory. From the MRP, the planned orders, a schedule indicating the amount and
timing of the future order can be decided.
2.3 Inventory Counting System
An inventory control system is an integrated package of software and hardware used
in warehouse operations, and elsewhere, to monitor the quantity, location and status
of inventory as well as the related shipping, receiving, picking and put away
processes.
2.3.1 Periodic system
Periodic inventory counting system is a physical count of items in inventory at
periodic interval in order to decide how much to order of each item, it can be once in
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Table 2.2: Comparison between periodic and perpetual inventory counting system
Inventory Counting
System
Periodic system Perpetual inventory
system
Advantages Orders for many items at
same time
Continuous monitoring of
inventory
Economies in processing Determine optimal
production order
2.4 Inventory Costs
There are three basic costs in maintaining the inventory; holding, transaction, and
shortage costs.
2.4.1 Holding costs
It is also call as carrying costs, cast is expense associated with maintaining inventory.
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2.4.1.2Taxes
Taxing authorities typically assess inventory held in warehouses. The tax rate and
means of assessment vary by location. The tax expense is usually a direct levy based
on inventory level on a specific day of the year or average level over a period of
time.
2.4.1.3 Insurance
Insurance cost is an expense based upon estimated risk or loss over time. The item
that are easily concealed like pocket cameras, transistor radios, calculator and fairly
expensive like cars, TV are prone to theft and pilferage, and some item that is easily
light fire like clothing, alcohol, these result in high insurance cost. Beside that, the
company facilities also influence the insurance cost such as security cameras and
sprinkler systems that might help to reduce risk.
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2.4.2 Ordering costs
It also calls as setup costs, the costs of ordering and receiving inventory. They are the
costs that vary with the actual placement of an order. Besides transportation cost,
shipping costs, preparing invoices, inspecting goods upon arrival for quality and
quantity, and moving the goods into temporary storage. For manufacturer which
produces its own inventory instead order from supplier, the ordering cost is cost of
machine setup, such as preparing equipment for job by adjusting the machine and
changing machine cutting tools are included into ordering costs.
2.4.3 Shortage costs
The costs result when demand exceeds the supply of inventory on hand. These costs
can include the opportunity cost of not making a sale, loss of customer goodwill, late
charges, and similar costs. Furthermore, if the shortage occurs in an item use at
internal, it can cause the cost of lost production.
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There are some assumptions of the basic EOQ model;
a) Only one product is involved
b) Annual demand requirement are known
c) Demand is spread evenly throughout the year so that the demand rate is
reasonably constant.
d) Lead time does not varye) Each order is received in a single delivery.
f) There are no quantity discount
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and the carrying costs also low, but its need more frequent orders, which increase the
annual ordering costs. Conversely, when the order size is larger, the average
inventory is high and therefore the carrying costs is increase, but the ordering costs is
decrease because the ordering infrequent interval.
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Annual ordering cost = $!%
Where; D = Demand, usually in units per year
S = Ordering cost
Because the number of orders per year, D/Q, decreases as Q increase, annual
ordering cost is inversely related to order size as figure above. The graph is showing
negative exponential. The total annual cost (TC) associated with carrying and
ordering inventory when Q units are ordered each time is
Total cost = Annual carrying cost + Annual ordering cost
&' ( )*#+,)% From this equation, the total cost reaches its minimum at the quantity where carrying
and ordering costs are equal. Thus;
-. ( / *012 The length of an order cycle is = Q/D
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The carrying cost for EPQ is almost same with the EOQ, the different is there are no
ordering costs, because the product is produce inside production section, and the
ordering quantity Q is replace by the inventory. The total cost for EPQ is
Total costs = carrying cost + setup cost
34567 ( 89:;< 2 +
=>?1
where,
I max = Maximum inventory
The economic run quantity is
-. ( / *012 /
@@AB
where,
p = production or delivery rate
u = usage rate
The cycle time for the economic run size models is a function of the run size and
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2.5.1.3 Quantity Discount
Quantity discount is a price reduction to the customer who order in a large
purchased. Generally there are two types:
a) Cumulative quantity discounts (also called accumulation discounts).
These are price reductions based on the quantity purchased over a set
period of time. The expectation is that they will impose an implied
switching cost and thereby bond the purchaser to the seller.
b) Non-cumulative quantity discounts. These are price reductions based on
the quantity of a single order. The expectation is that they will encourage
larger orders, thus reducing billing, order filling, shipping, and sales
personal expenses.
When the quantity discount is offered, some consideration have to take; the
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2.5.2 Ordering Time Interval
Reorder point (ROP) is when the quantity on hand of an item drops to this amount,
the item is reordered. This item amount is just sufficient to satisfy the expected
demand during the lead time. If the demand and lead time is constant, the reorder
point is simply
ROP = d X LT
Where;
d = demand rate (unit per day or week)
LT = Lead time in days or weeks (same unit as demand rate)
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Usually, the demand rate is not constant and variability, so it is necessary to carry
additional inventory call safety stock, to reduce the risk of running out of inventory
during lead time. The ROP then is increase by adding the safety stock.
ROP = expected demand during lead time + Safety stock
Safety stock is depending on the following factors;
a) The average demand rate and average lead time
b) Demand and lead time variability
c) The desired service level
The greater variability, the greater amount of safety stock are required to achieve the
service level, where the probability that demand will nor exceed supply during lead
time. So, the ROP is
ROP = Expected demand during lead time + z d LT
where,
z = number of standard deviations
d LT = the standard deviation of lead time demand
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The safety stock can be divided into three categories, the first is only demand is
variable, then
YZ[\ ( YZ] 3, and the reorder point isK_X ( ` a b^3 +cYZ] 3 Where;
a= average daily or weekly demand
d = standard deviation of demand per day or week
LT = lead time in days or weeks
Second is only lead time is variable, then d LT = d LT , and reorder point is
K_X ( ` a b^3 +cYZ[\ Whered = daily or weekly demand
^3 = average lead time in days or weeksLT = standard deviation of lead time in days or weeks
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CHAPTER 3
METHODOLOGY
3.1 Introduction
This chapter explained the research methodologies that were used in this study. The
methodology includes the planning of the study, survey instrument, and flow chart of
the research, data collection and analysis technique.
3.2 Planning of Study
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Figure 3.1: Flow chart for Planning of the Study
3.2.1 Flow Chart
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