Unit 3 CACEP Inventory Models

BE Degree Honours with
Specialization
BE Civil Engineering
Specialization in
CONSTRUCTION MANAGEMENT
Electives in Construction Management
21 CEB 07 T Computer Applications in
Construction Engineering and Planning
SYLLABUS Total Periods: 45 Credits 3
UNIT I INTRODUCTION 9
Overview of IT Applications in Construction – Construction process –
Computerization in Construction – Computer aided Cost Estimation –
Developing application with database software.
UNIT II OPTIMIZATION TECHNIQUES 9
Linear, Dynamic and Integer Programming - Branch and Bound Techniques –
Application to Production Scheduling, Equipment Replacement, Material
Transportation and Work Assignment Problems – Software applications
UNIT III INVENTORY MODELS 9
Deterministic and Probabilistic Inventory Models -
Software applications.
UNIT IV SCHEDULING APPLICATION 9
PERT and CPM - Advanced planning and scheduling concepts – Computer
applications – Case study.
UNIT V OTHER PROBLEMS 9
Sequencing problems – Simulation – Enterprises – ERP systems
TEXT BOOKS
1 Billy E. Gillet., Introduction to Operations Research – A
Computer Oriented Algorithmic Approach, McGraw Hill,
2008.
2 Feigenbaum, L., Construction Scheduling with
Primavera Project Planner Prentice Hall Inc., 2002.
3 Ming Sun and Rob Howard, “Understanding I.T. in
Construction, Spon Press, Taylor and Francis Group, 2004.
REFERENCES
4 Paulson, B.R., Computer Applications in Construction,
McGraw Hill, 1995.
5 Tarek Hegazy, Computer-Based Construction Project
Management, Pearson New International Edition, 2013.
UNIT III INVENTORY MODELS
Deterministic Inventory Models

Probabilistic Inventory Models
Software applications
21CEB07T Computer Applications in Construction Engineering and Planning

VELAMMAL Engineering College, Chennai – 600066
Department of Civil Engineering
T A Rajha Rajeswaran, Assistant Professor in Civil Engineering
What Is Inventory?
• Definition
• Types
• Examples

VELAMMAL Engineering College , Chennai – 600066

Subject for BE Honours in Civil Engineering with Specialization in CONSTRUCTION MANAGEMENT


What Is Inventory?
• Inventory refers to the
• Raw materials used in production
• Raw Materials under Production
process
• Goods / Products produced &
READY that are available for sale.

Inventory at Site
• A company's inventory represents
• one of the most important assets it has because the
turnover of inventory represents one of the primary
sources of revenue generation and subsequent
earnings for the company's shareholders.
• THREE types of Inventory, including
Raw Materials
Work-in-progress
Finished Goods.
It is categorized as a current asset on a company's
balance sheet.

• What Is Inventory?
• Inventory is simply defined as a stock or store
of goods.
• These goods are maintained and updated by a
business to meet the demands of its customers.
• Any business that deals with inventory will
know that it is also the process of tracking your
stock items and stock levels.
• This is so you can prepare and have the
capability to fill predicted orders.

4 Types of Inventory
1. Raw Materials
2. Work-In-Progress
3. Finished Goods
4. Overhaul / Maintenance, Repair and Operating Supplies
(MRO)

1. Raw Materials
• Inventory, at its most basic level,
is referred to as raw materials.
• RAW material needed in the first step of the production

process to turn your inventory into the finished product.
• For a very basic example, if you run a bakery whose key stock
is decorative cakes, your raw materials would include eggs,
flour and sugar. These raw materials would make up the
finished product – which is the cake.

2 Work-In-Progress
• Inventory that is being worked on is referred to as Work-In-Progress or WIP
inventories for short.
• As the name suggests, it’s literally your semi-finished goods or any

unfinished products.
• Things that would be considered, in a cost perspective, WIP would include

raw materials, labor and any overhead costs.
• It also refers to the inventory needed for your end product to sell. So to stay
on the bakery analogy, the packing material you’d sell the cakes in would be
considered WIP.
• That’s because the cake cannot be sold to the customer unless it is stored in
the correct packaging. Therefore it’s literally a work-in-progress.

3. Finished Goods
• Simplest step to understand in the entire process.
• Your finished goods inventory is what you are
displaying for the customer.
• It’s goods that are ready to be purchased. It’s
your fully baked and decorated cake that is stored
in its box and on the shelf waiting to be bought.
• Essentially, any product that is ready to be sold is
considered finished goods.


4. Overhaul / Maintenance, Repair , Operating
Supplies (MRO)
• Overhaul or MRO inventory is about the specific details.
• It is the inventory that is required to assemble and
sell your finished goods but is not actually a part of
the product itself.
• For example, if you were a clothing manufacturer
making jeans, then the sewing machine and needles
would be considered MRO.
• Or if you run an office, then office supplies and
stationery would also fall into this category.

Types of Inventory Costs

1. Ordering Costs
2 Carrying Costs
3. Holding Costs
4. Stock-out Costs
5. Obsolescence Costs
6. Shrinkage Costs

1. Ordering Costs:
• The costs associated with placing an order for new
inventory, such as the cost of the goods themselves,
shipping and handling, and any other related expenses.
• Ordering costs are the costs associated with placing an
order for inventory. These costs can include the cost of
the inventory itself, the cost of shipping and handling,
and the cost of any taxes or tariffs that may be associated
with the order. Ordering costs can also include the cost
of any storage or warehousing fees that may be incurred
while the inventory is being held prior to shipment.


• 2. Carrying Costs:
• The costs associated with storing and keeping inventory on hand, such as
warehousing costs, insurance, and depreciation.
Carrying cost, also known as inventory holding cost, is the cost associated with
storing inventory. This cost can include storage fees, insurance, opportunity cost,
and shrinkage.
• Carrying cost is an important factor to consider when managing inventory because
it can have a significant impact on the bottom line. Too much inventory can tie up
working capital and lead to higher carrying costs. On the other hand, too little
inventory can lead to stock outs and lost sales.
• The goal is to find the sweet spot that minimizes carrying costs while still meeting
customer demand. This can be a challenge, but there are a few strategies that can
help.
• One way to reduce carrying costs is to implement
just-in-time (JIT) inventory management. This is a system where inventory is only
ordered and delivered as needed, which minimizes the amount of inventory on
hand.

• 3. Holding Costs:
• The concept of holding costs is important to understand when managing
inventory. Holding costs are the costs associated with storing and
maintaining inventory. These costs can include storage costs, insurance,
taxes, and depreciation.
• Inventory is an important part of any business, but it is also a cost.
Too much inventory can tie up cash that could be used elsewhere, and it
can also create storage and maintenance problems. Managing inventory
so that it is at the right level is crucial to a company’s bottom line.
• The goal is to have enough inventory on hand to meet customer demand,
but not so much that it becomes a burden. That means that businesses
need to strike a balance between customer service and holding costs.
• There are a number of ways to reduce holding costs. One is to reduce the
amount of inventory on hand. This can be done by increasing the
frequency of deliveries from suppliers or by reducing the lead time for
orders. 21CEB07T Computer Applications in Construction Engineering and Planning

4. Stock-out Costs:
• The costs associated with not having enough inventory on hand to
meet customer demand, such as lost sales and lost opportunity costs.
Stock-outs can be frustrating and costly, but there are ways to
minimize the cost of a stock-out and get your business back on track.
• The first step is to understand the cost of a stock-out. There are direct
and indirect costs associated with a stock-out. Direct costs include the
cost of the item that is out of stock, the cost of shipping the
replacement item, and the cost of lost sales. Indirect costs include the
cost of lost productivity and the cost of lost customer goodwill.
• Once you know the cost of a stock-out, you can take steps to minimize
the cost. One way to do this is to have a good inventory management
system in place. This will help you to keep track of your inventory
levels and help you to avoid stock-outs.


• 5. Obsolescence Costs:
• The costs associated with inventory that is no longer needed or used, such as the
cost of disposal or the cost of storage for unused items.
• Obsolescence costs are the costs associated with replacing or upgrading
equipment, systems, or products that have reached the end of their useful life.
These costs can include the cost of new equipment, installation, training, and
disposal of the old equipment.
• For businesses, obsolescence costs can be a significant expense, especially if they
have to replace large pieces of equipment or systems. Obsolescence can also
cause disruptions in business operations as new equipment is installed or
employees are trained on how to use it.
• There are a few ways to manage obsolescence costs. One is to plan for them in the
budgeting process. This can help businesses avoid the financial shock of a large
unexpected expense. Another way to manage obsolescence costs is to lease
equipment instead of buying it. This can help businesses spread the cost of new
equipment over time and avoid the need to dispose of old equipment.


• 6. Shrinkage Costs:
• The costs associated with inventory that is damaged, destroyed, or stolen.
There’s no denying that shrinkage is a huge problem for retailers. In fact,
it’s estimated that shrinkage costs the retail industry $100 billion annually.
That’s a lot of money that could be going back into businesses and benefiting
the economy as a whole.
• There are a number of reasons why shrinkage occurs. One of the most common
is theft by employees. This can happen when employees are dissatisfied with
their wages or working conditions. They may feel that they’re not being paid
enough for the work they do or that their job is not fulfilling. As a result, they
may decide to steal from the company to make up for what they feel is missing.
• Other causes of shrinkage include shoplifting, errors in inventory, and damage
to products. Whatever the cause, shrinkage is a huge problem for retailers. It’s
important to be aware of the causes of shrinkage and to take steps to prevent
it.




Calculating Inventory Cost:
• Inventory cost is the cost of goods that a company has in stock. It
includes the cost of the materials, labor, and other expenses
incurred in the production of the goods. The inventory cost formula
is:
Materials cost + Labor cost + Other Expenses
Inventory cost = ---------------------------------------------------------------
Number of Units in Stock
• The inventory cost formula is used to calculate the cost of goods

that a company has in stock. This information is important for
businesses to know so that they can price their goods appropriately
and make informed decisions about inventory levels.

Inventory Cost Methods

1. First-in, first-out (FIFO) method
2. Last-in, first-out (LIFO) method
3. Weighted Average cost
4. Specific Identification
5. Standard Cost

1. First-in, first-out (FIFO) method:
• Inventory cost is based on the order in which it is acquired.
• The first items that are acquired are assumed to be the first
items that are sold, and the cost of those items is charged
to expense as they are sold.
• The remaining inventory is then valued at the cost of the
most recent purchase.
• This method is used because it is easy to track and it
provides a consistent cost basis for inventory.
• Main Disadvantage of the FIFO method is that it does not
necessarily reflect the true cost of the inventory that is on
hand.

2. Last-in, first-out (FIFO) method:
• If you use the inventory cost method LIFO, you are essentially valuing
your inventory using the prices of the most recent goods you’ve
purchased. That means that if prices have gone up, your inventory will
be valued higher than if you had used another method.
• There are a few advantages to using LIFO. First, it more accurately
reflects the current value of your inventory. Second, it can help you
manage your taxes, since you’ll generally be paying taxes on the most
recent, and therefore most expensive, goods you’ve purchased.
• There are a few potential drawbacks to using LIFO as well. First, it can
create distortions in your financial statements if prices fluctuate a lot.
Second, it can be difficult to change from another inventory cost
method to LIFO, since it can have a big impact on your taxes.


3. Weighted average cost:
• Weighted average cost is a method used to calculate the average cost of inventory items that
have different costs. The weighted average cost is calculated by multiplying the number of units
of each item by its cost, adding up these products, and dividing the total by the number of units
in the inventory.
• This average cost per unit is then used to value the inventory and to determine the cost of
goods sold when items are sold. The weighted average cost method assumes that the units in
the inventory are interchangeable and that the cost of the items being sold is the average cost
of all the items in the inventory.
• This method is useful in cases where there is frequent movement of inventory, as it provides a
more accurate reflection of the cost of goods sold compared to using a specific identification
method or the first-in, first-out (FIFO) method.
• The formula for calculating weighted average cost is:
• Weighted Average Cost = (Total Cost of Inventory) / (Total Number of Units in Inventory)
• Where:
• Total Cost of Inventory = Sum of the cost of each item in the inventory
Total Number of Units in Inventory = Sum of the number of units of each item in the inventory.
• The weighted average cost can be calculated on a periodic basis (e.g., daily, weekly, monthly) to
reflect changes in inventory levels and cost.


• 4. Specific identification:
• Specific Identification is a method of determining the cost of inventory that
assigns a specific cost to each unit of inventory based on its unique
characteristics, such as serial number or production date. This method is
used when the inventory items are unique or have different costs, and the
cost per unit is easily traced.
• In this method, the cost of each unit of inventory is tracked separately, and
the cost of goods sold is determined based on the specific units that are
sold. This method is useful in cases where the inventory items are unique,
such as one-of-a-kind works of art, or where the cost per unit is easily
traced, such as with serialized items.
• The advantage of the specific identification method is that it provides a
more accurate reflection of the cost of goods sold compared to other
methods, such as weighted average or first-in, first-out (FIFO). However, it
also requires more detailed record-keeping, which can be time-consuming
and expensive.

• 5. Standard cost:
• Standard cost is a method of determining the cost of inventory items by using
predetermined costs for each item. The predetermined costs are based on factors such
as labor and material costs, and are used to value the inventory and determine the
cost of goods sold. The standard cost is established in advance, before the inventory is
produced or acquired, and is used as a benchmark for measuring actual performance.
• In the standard cost method, if the actual costs incurred during the production or
acquisition of the inventory items are different from the predetermined standard costs,
the difference is recorded as a variance. The variances are analyzed to determine the
cause of the difference and to identify opportunities for improvement.
• The advantage of the standard cost method is that it provides a benchmark for
measuring actual performance and for identifying opportunities for improvement. This
can be useful for companies that need to control costs, such as those operating in highly
competitive industries.
• The standard cost method also requires regular updates to the standard costs to reflect
changes in production processes, materials, and other factors. Additionally, the method
assumes that the standard costs accurately reflect the actual costs, which may not
always be the case.


Factors Affecting Inventory Cost
• Production Volume
• Lead Time
• Order Quantity
• Carrying Cost
• Obsolescence Cost
• Market Demand
• Prices of Raw Materials

Factors Affecting Inventory Cost:

• Production Volume: The amount
of goods produced has an impact
on the cost of inventory as
production costs increase with
larger volumes.



• Lead Time: The time taken from
ordering raw materials to
receiving them affects the cost of
inventory as longer lead times
result in increased storage costs.



• Order Quantity: The size of an
order affects the cost of inventory
as larger orders can lead to bulk
discounts, but also result in
increased storage costs.



• Carrying Cost: The cost of holding
inventory includes expenses such
as storage, insurance, and taxes.
It increases with the amount of
inventory held and the length of
time it is held.


• Obsolescence Cost: The cost of
inventory that is not sold or used
is referred to as obsolescence
cost, which increases as the
length of time inventory is held
increases.


• Market Demand: The demand for
a product affects inventory costs
as changes in demand can lead to
overstocking or stock shortages,
both of which can result in
increased costs.


• Prices of Raw Materials: The cost
of raw materials affects the cost
of inventory as price changes can
result in increased production
costs.


Impact of Over Inventory Cost on a Business:
• Reduced profitability and competitiveness
• Tied up financial resources
• Decreased operating margins
• Lowered returns on investment
• Decreased company value
Impact of Low Inventory Cost on a Business:
• Improved financial performance
• Increased competitiveness
• Freed up financial resources
• Improved customer satisfaction
• Reduced stockouts.

Strategies to Manage Inventory Costs
• Safety Stock Management

• Economic Order Quantity (EOQ)
• Forecasting and Planning
• Cost Reduction Initiatives
• Technology Adoption

Safety Stock Management:
• Safety stock is an extra amount of
inventory held to ensure availability in
case of unanticipated demand or
supply chain disruptions.
• By managing safety stock levels
effectively, businesses can reduce the cost
of carrying excess inventory.

• Economic Order Quantity (EOQ)

This model
calculates the optimal order quan
tity
to minimize the total cost of
ordering and carrying inventory.

Forecasting & Planning:
• Accurate forecasting and planning can
help businesses make informed
decisions about inventory levels,
reducing the
risk of overstocking or stock shortages,
and minimizing inventory carrying
costs. 21CEB07T Computer Applications in Construction Engineering and Planning

Cost Reduction Initiatives:

• Cost reduction initiatives such as
negotiating better terms with sup
pliers
, reducing waste, and improving
production processes can help
lower the cost of inventory.

Technology Adoption:
• The use of technology such as
inventory management software and
automated systems can help businesses
monitor inventory levels, track costs,
and
make data-driven decisions about invent
ory management
.
VELAMMAL Engineering College
Department of Civil Engineering , Chennai – 600066

Methods to control Inventory Cost

• Negotiate Better Terms with Suppliers
• Optimize Order Quantities
• Improve Lead Time Management
• Minimize Excess Inventory
• Implement a Cycle Counting Program
• Automate Inventory Management
• Use Technology to Monitor Inventory Levels:

• Negotiate Better Terms with Suppliers:
Negotiating better payment terms, discounts, or bulk pricing with supplierscan lower the cost
of raw materials and production costs, reducing the overall cost of inventory.
• Optimize Order Quantities: Using the Economic Order Quantity (EOQ) model or other
inventory optimization techniques can help businesses determine the optimal order quantities
to minimize the total cost of ordering and carrying inventory.
• Improve Lead Time Management: Shortening lead times by collaborating with suppliers or
using expedited shipping options can reduce the need for safety stock and minimize inventory
carrying costs.
• Minimize Excess Inventory: By closely monitoring inventory levels and avoiding overstocking,
businesses can reduce the cost of carrying excess inventory.
• Implement a Cycle Counting Program: Regular cycle counting can help businesses identify
discrepancies in inventory levels, reduce the risk of stock shortages, and minimize
obsolescence costs.
• Automate Inventory Management: Automated inventory management systems can help
businesses monitor inventory levels, track costs, and make data-driven decisions about
inventory management, reducing the risk of overstocking or stock shortages.
• Use Technology to Monitor Inventory Levels: The use of barcode scanning, RFID technology,
or other inventory tracking methods can help businesses monitor inventory levels in real-time
and make informed decisions about inventory management.



CLASSIFICATION OF INVENTORY MODELS


DETERMINISTIC Inventory MODEL
• Deterministic inventory models in which

demand rate of an item is assumed to be
constant.


• ECONOMIC ORDER QUANTITY MODEL: The order size of an
inventory that minimizes the total cost of inventor management is
known Economic Order Quantity. It expressed by this
Mathematical formula.
• E.O.Q. =
where,
• Oc= Cost Of Order,
• D = Annual Demand,
• Hc= Holding Cost/Carrying Cost [in Rs. or Unit]
•

EOQ Model
Economic
Order
Quantity



EOQ Model


EPQ
Economic Production Quantity Model


• EPQ --- ECONOMIC PRODUCTION
QUANTITY MODEL:
• Economic production quantity (EPQ) is
the quantity of a product
• that should be manufactured in a single
batch
• so as to minimize the total cost that
includes set-up costs of machines and
inventory holding costs.

• Economic Production Quantity model
(also known as the EPQ model)
• determines the quantity a company or retailer should
order to minimize the total inventory costs by
balancing the inventory holding cost and average fixed
ordering cost.


EPQ Model


Basis EOQ EPQ
Economic order quantity is the Economic production quantity is the

optimum order size that should be optimum lot size that is to be
Meaning placed with a vendor to minimize manufactured in a production unit to
blockage of funds and holding and avoid unnecessary blockage of funds
ordering costs and excess storage costs
EOQ= √‾‾(2xDxO/ H)
Formula EPQ= Square root of {2xDx O/ H(1-x)}
the square root of (2xDxO/ H).
The company itself is not The company is the producer itself of

Production producing the item under the product or the part under
consideration consideration
The presence of constant lead time is

Lead Time There is no such assumption
assumed


PROBABILISTIC
MODELS


CLASSIFICATION OF INVENTORY MODELS


• Probabilistic Inventory Models

where
• the demand for an item fluctuates
• or we can say
• the demand is
• not known properly.



SINGLE-PERIOD INVENTORY MODELS:

Single- Period Inventory model
refers to
inventory situations
in which
one order is placed for the product;
at the end of the period, the product has
either sold out, or there is a surplus of unsold
items that will be sold for a salvage value

• Typically orders are made only once.
• They are also

known as the Dollar Limit System
and are used for one time ordering
for seasonal products or spare parts
purchases.

Single Period Inventory This model

mathematical expression is:


• MULTI PERIOD INVENTORY MODEL:
• Orders are placed multiple times over the entire
production cycle.
This model further classified under two categories.
• There are two general types of multi period inventory
systems:
• fixed- order quantity models (also called the economic
order quantity, EOQ, and Q-Model) and
• fixed-time period models (also referred to periodic
system, periodic review system, fixed–order interval
system, and P-Model).



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BE Degree Honours with

Deterministic Inventory Models

21CEB07T Computer Applications in Construction Engineering and Planning

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

4. Overhaul / Maintenance, Repair and Operating Supplies

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

• RAW material needed in the first step of the production

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

• As the name suggests, it’s literally your semi-finished goods or any

• Things that would be considered, in a cost perspective, WIP would include

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

Types of Inventory Costs

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

• The inventory cost formula is used to calculate the cost of goods

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

Inventory Cost Methods

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

Factors Affecting Inventory Cost:

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

Factors Affecting Inventory Cost:

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

Factors Affecting Inventory Cost:

21CEB07T Computer Applications in Construction Engineering and Planning

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering

Factors Affecting Inventory Cost:

T A Rajha Rajeswaran, Assistant Professor in Civil Engineering