BAOPNMAX CM Week11-12 ACT102

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Subject Code: BAOPNMAX
Subject Title: Operations Management and Total Quality Management
Subject Description: This course tackles the nature, scope, functions and importance of
production and operations management in business. It includes
discussions on productivity, competitiveness and strategy,
forecasting, production system design, process selection and
capacity planning, facilities layout, design of work systems, quality,
scheduling and just-in-time manufacturing systems. Cases will also
be used to illustrate and apply the basic production and operations
concepts and tools commonly used in business firms. Total Quality
Management will familiarize students with the basic principles and
methods associated with Total Quality and Performance Excellence,
how these principles and methods have been put into effect in a
variety of organizations, and to illustrate the relationship between
principles and theories in the study of business courses especially
programs that discusses managing of people and industry.
No. of Units: 3
Class Schedule: ACT102: Face-to-Face: Saturday 1:00pm – 5:00pm
Course Learning Outcomes:

At the end of the course, the student will be able to:
1. Analyze the importance of quality management towards cost reduction. Report on project
management and its importance.
2. Demonstrate how to design goods and services and how managing quality may provide
competitive advantage.
3. Evaluate the relevance of leadership, human management and supply-chain management
to sustainability.
4. Assess the strategic importance of inventory management, maintenance, and decisions
related to processes, location and layout/facility.
About the Instructor:

PROF. MARK ANTHONY R. LAZARO, LPT, MBA
● Professional Lecturer 4 – National University Baliwag , December 2022 to Present
● Administrative Payroll Specialist – Philippine Airlines, 2016 to Present
● Licensed Professional Teacher – October 2022
● Master in Business Administration – Baliuag University, 2022
● Continuing Professional Teacher Education (CPTE) – Baliwag Polytechnic College, 2019
● Bachelor of Science in Accountancy – Baliuag University, 2015
● Bachelor of Science in Business Administration, Baliuag University, 2013
SM Baliwag Complex, Dona Remedios Trinidad Highway, Brgy. Pagala, Baliwag, Bulacan
(+63) 927-533-0342 – (+63) 923-949-5265 admissions-nubaliwag@nu.edu.ph
Topic 7
MANAGING INVENTORIES
Objectives:
▪ Explain the importance of inventory, types of inventories, and key decisions and costs.
▪ Describe the major characteristics that impact inventory decisions.
▪ Describe how to conduct an ABC inventory analysis.
▪ Explain how a fixed-order-quantity inventory system operates, and how to use the EOQ
and safety stock models.
▪ Explain how a fixed-period inventory system operates.
▪ Describe how to apply the single-period inventory model.
➢ Inventory is any asset held for future use or sale.

Objectives:
➢ Maintain sufficient inventory
➢ Incur lowest possible cost
➢ Inventory Management involves planning, coordinating, and controlling the acquisition,
storage, handling, movement, distribution, and possible sale of raw materials, component
parts and subassemblies, supplies and tools, replacement parts, and other assets that are
needed to meet customer wants and needs.
Understanding Inventory
• Raw materials, component parts, subassemblies, and supplies are inputs to
manufacturing and service-delivery processes.
• Work-in-process (WIP) inventory consists of partially finished products in various stages
of completion that are awaiting further processing.
• Finished goods inventory is completed products ready for distribution or sale to
customers.
• Safety stock inventory is an additional amount of inventory that is kept over and above the
average amount required to meet demand.
Role of Inventory in the Value Chain
Managing Inventories in Global Supply Chains
• Purchasing, tracking, and managing such a variety of items in global supply chains
requires good technology, processes, and information technology (IT) support.
• Purchasing must focus on global sourcing and total system cost; ensure quality, delivery
performance, and technical support; and seek new suppliers and products and be able to
evaluate their potential to the company.
• Environmentally Preferable Purchasing (EPP), or green purchasing, is the affirmative
selection and acquisition of products and services that most effectively minimize negative
environmental impacts over their life cycle of manufacturing, transportation, use, and
recycling or disposal.
Inventory Management Decisions and Costs

Inventory managers deal with two fundamental decisions:
1. When to order items from a supplier or when to initiate production runs if the firm
makes its own items
2. How much to order or produce each time a supplier or production order is placed
Four categories of inventory costs:
1. Ordering or setup costs
2. Inventory-holding costs
3. Shortage costs
4. Unit cost of the stock-keeping units (SKUs)
• Ordering costs or setup costs are incurred as a result of the work involved in placing
purchase orders with suppliers or configuring tools, equipment, and machines within a
factory to produce an item.
• Inventory-holding costs or inventory-carrying costs are the expenses associated with
carrying inventory.
• Shortage costs or stockout costs are the costs associated with a SKU being unavailable
when needed to meet demand.
• Unit cost is the price paid for purchased goods or the internal cost of producing them.
Inventory Characteristics
Number of items: each item is identified by a unique identifier, called a stock-keeping unit (SKU).
➢ A stock-keeping unit (SKU) is a single item or asset stored at a particular location.
Nature of Demand:
• Independent demand is demand for an SKU that is unrelated to the demand for other SKUs
and needs to be forecast.
• Dependent demand is demand directly related to the demand for other SKUs and can be
calculated without needing to be forecast.
• Demand can either be constant (deterministic) or uncertain (stochastic)
• Static demand is stable demand.
• Dynamic demand varies over time.
Number and Duration of Time Periods:
• Single period
• Multiple time periods
Lead Time:
• The lead time is the time between placement of an order and its receipt.
Stockouts:
• A stockout is the inability to satisfy demand for an item.
• A backorder occurs when a customer is willing to wait for an item.
• A lost sale occurs when the customer is unwilling to wait and purchases the item elsewhere.
ABC Inventory Analysis
ABC inventory analysis categorizes SKUs into three groups according to their total annual dollar
usage
1. “A” items account for a large dollar value but a relatively small percentage of total items
2. “C” items account for a small dollar value but a large percentage of total items
3. “B” items are between A and C
ABC Inventory (Pareto) Analysis
• “A” items account for a large dollar value but relatively small percentage of total items
(e.g., 10% to 30 % of items, yet 60% to 80% of total dollar value).
• “C” items account for a small dollar value but a large percentage of total items (e.g., 50%
to 60% of items, yet about 5% to 15% of total dollar value). These can be managed using
automated computer systems.
• “B” items are between A and C.
Solved Problem
The data show projected annual dollar usage for 20 items. Exhibit 12.3 shows the data sorted, and
indicates that about 70% of total dollar usage is accounted for by the first 5 items.
Excel ABC Template Before Sorting
Excel ABC Template After Sorting
ABC Histogram for the Results from Exhibit 12.3
Managing Fixed Quantity Inventory Systems

➢ In a fixed quantity system (FQS), the order quantity or lot size is fixed; the same amount,
Q, is ordered every time.
• The fixed order (lot) size, Q, can be a box, pallet, container, or truck load.
• Q does not have to be economically determined, as we will do for the EOQ model
later.
• The process of triggering an order is based on the inventory position.
• Inventory position (IP) is the on-hand quantity (OH) plus any orders placed but which
have not arrived (scheduled receipts, or SR), minus any backorders (BO).
IP = OH + SR – BO
▪ When inventory falls at or below a certain value, r, called the reorder point, a new order
is placed.
➢ The reorder point is the value of the inventory position that triggers a new order.
Summary of Fixed Quantity System (FQS)
Fixed Quantity System (FQS) under Stable Demand
Fixed Quantity System (FQS) with Highly Variable Demand
The EOQ Model

The Economic Order Quantity (EOQ) model is a classic economic model developed in the early
1900s that minimizes total cost, which is the sum of the inventory-holding cost and the ordering
cost.
Assumptions:
• Only a single item (SKU) is considered.
• The entire order quantity (Q) arrives in the inventory at one time.
• Only two types of costs are relevant—order/setup and inventory holding costs.
• No stockouts are allowed.
• The demand for the item is deterministic and continuous over time.
• Lead time is constant.
Cycle inventory (also called order or lot size inventory) is inventory that results from
purchasing or producing in larger lots than are needed for immediate consumption or sale.
Average cycle inventory
= (Maximum inventory + Minimum inventory)/2
= Q/2
Cycle Inventory Pattern for the EOQ Model
The EOQ Model

Inventory Holding Cost
The cost of storing one unit in inventory for the year, Ch, is
Ch = (I)(C)
where
I = annual inventory-holding charge expressed as a percent of unit cost
C = unit cost of the inventory item or SKU
Annual inventory-holding cost is computed as:
Ordering Cost
If D = annual demand and we order Q units each time, then we place D/Q orders/year.
Annual ordering cost is computed as :
where C0 is the cost of placing one order
Total Annual Cost

Total annual cost is the sum of the inventory holding cost plus the order or setup cost:
Economic Order Quantity

The EOQ is the order quantity that minimizes the total annual cost
Calculating the Reorder Point

The reorder point, r, depends on the lead time and demand rate.
Multiply the fixed demand rate d by the length of the lead time L (making sure they are
expressed in the same units, e.g., days or months):
r = Lead time demand = (demand rate)(lead time)
= (d)(L)
Solved Problem
D = 24,000 cases per year.
Co = $38 per order.
I = 18 percent.
C = $12.00 per case.
Ch = IC = $2.16.
1 24,000
TC = Q($2.16) + ($38.00)
2 Q
2(24,000)(38)
EOQ = = 919 cases rounded to a whole number.
2.16
Excel Spreadsheet from EOQ Model Template
Safety Stock and Uncertain Demand in a Fixed Order Quantity System

• When demand is uncertain, using EOQ based on the average demand will result in a high
probability of a stockout.
– Safety stock is additional planned on-hand inventory that acts as a buffer to reduce
the risk of a stockout.
– A service level is the desired probability of not having a stockout during a lead-
time period.
• When a normal probability distribution provides a good approximation of lead time
demand, the general expression for reorder point is
r = mL + zsL
where
mL = average demand during the lead time
sL = standard deviation of demand during the lead time
z = the number of standard deviations necessary to achieve the acceptable service level
“zsL” represents the amount of safety stock.
We may not know the mean and standard deviation of demand during the lead time, but only for
some other length of time, t, such as a month or year. Suppose that mt and st are the mean and
standard deviation of demand for some time interval t, If the distributions of demand for all time
intervals are identical to and independent of each other, then
mL = m t L
sL = st √L
Solved Problem
Southern Office Supplies, Inc. distributes laser printer paper.
– Ordering costs are $45.00 per order,
– One ream of paper costs $3.80,
– Annual inventory-holding cost rate is 20%.
– The average annual demand is 15,000 reams, or about 15,000/52 = 288.5 per week
– The standard deviation of weekly demand is about 71
– The lead time from the manufacturer is two weeks.
Inventory-holding cost is Ch = IC = 0.20($3.80) = $0.76 per ream per year.
Solved Problem
• The average demand during the lead time is (288.5)(2) = 577 reams,
• The standard deviation of demand during the lead time is approximately 71√2 = 100 reams.
• The EOQ model results in an order quantity of 1333, reorder point of 577, and total annual
cost of $1,012.92.
• Desired service level of 95%, which results in a stockout of roughly once every 2 years.
For a normal distribution, this corresponds to a standard normal z-value of 1.645.
r = mL + zsL = 577 = 1.645(100) = 742 reams
• This policy increases the reorder point by 742 – 577 = 165 reams, which represents the
safety stock.
• The cost of the additional safety stock is Ch times the amount of safety stock, or
($0.76/ream)(165 reams) = $125.40.
Managing Fixed Period Inventory Systems
An alternative to a fixed order quantity system is a fixed period system (FPS)—sometimes called
a periodic review system—in which the inventory position is checked only at fixed intervals of time,
T, rather than on a continuous basis.
Two principal decisions in a FPS:
1. The time interval between reviews (T), and
2. The replenishment level (M)
Economic time interval: T = Q*/D
Optimal replenishment level without safety stock:
M = d (T + L)
where d = average demand per time period
L = lead time in the same time units
M = demand during the lead time plus
review period
Summary of Fixed Period Inventory Systems
Operation of a Fixed Period Systems (FPS)
Uncertain Demand
• Compute safety stock over the period T + L.
• The replenishment level is computed as:
M = mT+L + zσT+L
mT+L = mt (T + L)
σT+L = σt √T + L
Excel FPS Safety Stock Template
Single-Period Inventory Model

• Applies to inventory situations in which one order is placed for a good in anticipation of a
future selling season where demand is uncertain.
• At the end of the period, the product has either sold out or there is a surplus of unsold items
to sell for a salvage value.
• Sometimes called a newsvendor problem, because newspaper sales are a typical example.
• Solve using marginal economic analysis.
• cs = the cost per item of overestimating demand (salvage cost); this cost represents
the loss of ordering one additional item and finding that it cannot be sold.
• cu = the cost per item of underestimating demand (shortage cost); this cost
represents the opportunity loss of not ordering one additional item and finding that
it could have been sold.
• The optimal order quantity Q* must satisfy:
Solved Problem
• A buyer orders fashion swimwear about six months before the summer season.
• Each piece costs $40 and sells for $60.
• At the sale price of $30, it is expected that any remaining stock can be sold during the
August sale.
• The cost per item of overestimating demand is equal to the purchase cost per item minus
the August sale price per item:cs = $40 – $30 = $10.
• The per-item cost of underestimating demand is the difference between the regular selling
price per item and the purchase cost per item; that is, cu = $60 – $40 = $20.
Solved Problem
Assume that a uniform probability distribution ranging from 350 to 650 items describes the
demand.
Solved Problem
The optimal order size Q must satisfy:
P(demand ≤ Q*) = cu /(cu + cs)
= 20/(20+10) = 2/3
Because the demand distribution is uniform, the value of Q* is two-thirds of the way from 350 to
650. This results in Q* = 550.
Excel Single Period Inventory Template
Hardy Hospital Case Study

1. What are good estimates of order cost and inventory holding cost? (State all assumptions
and show all computations)
2. What is the EOQ and reorder point for Strike Disinfectant given your answer to Question
1?
3. Compute the total order and inventory holding costs for a Fixed Quantity System (FQS)
and compare to their current order Q's. Can you save money by adopting a FQS?
4. What are your final recommendations, including what you would recommend regarding
regular and special orders, the state bidding system, and overall control of the university
materials management system? Explain the reasoning for your recommendations.

BAOPNMAX CM Week11-12 ACT102

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DISCLAIMER: The information content provided in this course material is designed to provide

Subject Code: BAOPNMAX

Subject Title: Operations Management and Total Quality Management

Class Schedule: ACT102: Face-to-Face: Saturday 1:00pm – 5:00pm

Course Learning Outcomes:

About the Instructor:

➢ Inventory is any asset held for future use or sale.

Inventory Management Decisions and Costs

Excel ABC Template After Sorting

Managing Fixed Quantity Inventory Systems

Summary of Fixed Quantity System (FQS)

Fixed Quantity System (FQS) with Highly Variable Demand

The EOQ Model

The EOQ Model

Total Annual Cost

Economic Order Quantity

Calculating the Reorder Point

Safety Stock and Uncertain Demand in a Fixed Order Quantity System

Summary of Fixed Period Inventory Systems

Operation of a Fixed Period Systems (FPS)

Excel FPS Safety Stock Template

Single-Period Inventory Model

Hardy Hospital Case Study

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