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HANSEN & MOWEN

Cost Management ACCOUNTING AND CONTROL Inventory Management: EOQ , JIT and the Theory of Constraints. HANSEN & MOWEN. 1. Just-in-Case Inventory Management. OBJECTIVE. Three types of inventory costs can be readily identified with inventory:. The cost of acquiring inventory.

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HANSEN & MOWEN

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  1. Cost ManagementACCOUNTING AND CONTROLInventory Management: EOQ, JITand the Theory of Constraints HANSEN & MOWEN

  2. 1 Just-in-Case Inventory Management OBJECTIVE Three types of inventory costs can be readily identified with inventory: • The cost of acquiring inventory. • The cost of holding inventory. • The cost of not having inventory on hand when needed.

  3. 1 Just-in-Case Inventory Management OBJECTIVE 1. Ordering Costs:The costs of placing and receiving an order. Examples:Clerical costs, documents, insurance for shipment, and unloading. 2. Setup Costs: The costs of preparing equipment and facilities so they can be used to produce a particular product or component. Examples:Setup labor, lost income (from idled facilities), and test runs.

  4. 1 Just-in-Case Inventory Management OBJECTIVE 3. Stock-Out Costs: The costs of not having sufficient inventory. Examples:Lost sales, costs of expediting (extra setup, transportation, etc.) and the costs of interrupted production. 4. Carrying Costs:The costs of carrying inventory. Examples:Insurance, inventory taxes, obsolescence, opportunity cost of capital tied up in inventory, and storage.

  5. 1 Just-in-Case Inventory Management OBJECTIVE Traditional Reasons for Carrying Inventory

  6. 1 Just-in-Case Inventory Management OBJECTIVE The total ordering (or setup) and carrying cost The cost of placing and receiving an order (or the cost of setting up a production run) The known annual demand The number of units ordered each time an order is placed (or the lot size for production) The cost of carrying one unit of stock for one year Economic Order Quantity TC = PD/Q + CQ/2

  7. 1 Just-in-Case Inventory Management OBJECTIVE EOQ =  (2 x 25,000 x $40) / $2 EOQ =  1,000,000 EOQ = 1,000 units An EOQ Illustration EOQ =  2PD/C D = 25,000 units Q = 500 units P = $40 per order C = $2 per unit

  8. 1 Just-in-Case Inventory Management OBJECTIVE When to Order or Produce Reorder point = Rate of usage x Lead time Example: Assume that the average rate of usage is 100 parts per day. Assume also that the lead time is 4 days. What is the reorder point? Reorder point = 4 x 100 = 400 units Thus, an order should be placed when inventory drops to 400 units.

  9. 1 Just-in-Case Inventory Management OBJECTIVE The Reorder Point

  10. 1 Just-in-Case Inventory Management OBJECTIVE Maximum usage 120 Average usage -100 Difference 20 Lead time x 4 Safety stock 80 Demand Uncertainty and Reordering To avoid running out of parts, organizations often choose to carry safety stock. Safety stock is extra inventory carried to serve as insurance against fluctuations in demand. Example: If the maximum usage of the VCR part is 120 units per day, the average usage is 100 units per day, and the lead time is four days, the safety stock is 80.

  11. 1 Just-in-Case Inventory Management OBJECTIVE EOQ and Reorder Point Illustrated

  12. 2 JIT Inventory Management OBJECTIVE Setup and Carrying Costs: The JIT Approach JIT reduces the costs of acquiring inventory to insignificant levels by: 1. Drastically reducing setup time 2. Using long-term contracts for outside purchases Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels.

  13. 2 JIT Inventory Management OBJECTIVE Due-Date Performance: The JIT Solution Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand. Lead times are reduced by: • reducing setup times • improving quality • using cellular manufacturing

  14. 2 JIT Inventory Management OBJECTIVE Avoidance of Shutdown: The JIT Approach • Total preventive maintenance to reduce machine failures • Total quality control to reduce defective parts • The use of the Kanban system is also essential

  15. A withdrawal Kanban A production Kanban A vendor Kanban 2 JIT Inventory Management OBJECTIVE What is the Kanban System? A card system is used to monitor work in process The Kanban system is responsible for ensuring that the necessary products are produced in the necessary quantities at the necessary time.

  16. 2 JIT Inventory Management OBJECTIVE Production Kanban Withdrawal Kanban

  17. 2 JIT Inventory Management OBJECTIVE Vendor Kanban

  18. 2 JIT Inventory Management OBJECTIVE The Kanban Process

  19. 2 JIT Inventory Management OBJECTIVE Discounts and Price Increases: JIT Purchasing versus Holding Inventories • Careful vendor selection • Long-term contracts with vendors • Prices are stipulated (usually producing a significant savings) • Quality is stipulated • The number of orders placed are reduced

  20. 2 JIT Inventory Management OBJECTIVE JIT Limitations • Patience in implications is needed. • Time is required. • JIT may cause lost sales and stressed workers. • Production may be interrupted due to an absence of inventory.

  21. 3 Basic Concepts of Constrained Optimization OBJECTIVE Every firm faces limited resources and limited demand for each product. • External constraints, such as market demand • Internal constraints, such as machine or labor time availability Constrained optimizationis choosing the optimal mix given the constraints faced by the firm.

  22. 3 Basic Concepts of Constrained Optimization OBJECTIVE Total contribution margin Linear Programming The unit contribution margins are $300 and $600 for X and Y, respectively. Z = $300X + $600 Y This equation is called the objective function, the function to be optimized.

  23. 3 Basic Concepts of Constrained Optimization OBJECTIVE Internal constraints: X + Y  80 X + 3Y  120 2X + Y  90 External constraints: X  60 Y  100 Linear Programming

  24. 3 Basic Concepts of Constrained Optimization OBJECTIVE Linear Programming X + Y  80 X + 3Y  120 2X + Y  90 X  60 Y  100 X  0 Y  0

  25. 3 Basic Concepts of Constrained Optimization OBJECTIVE B C A D Graphical Solution 160 140 120 100 80 60 40 20 X  60 Y  100 2X + Y  90 X + Y  80 X + 3Y  120 20 40 60 80 100 120 140

  26. 3 Basic Concepts of Constrained Optimization OBJECTIVE Linear Programming Corner Point X-Value Y-Value Z = $300X + $600Y A 0 0 $ 0 B 0 40 24,000 C 30 30 27,000 D 45 0 13,500 C is the optimal solution!

  27. Throughput Inventory Operating expenses 4 Theory of Constraints OBJECTIVE (Sales revenue – Unit-level variable expenses)/Time Three Measures of Systems Performance:

  28. 4 Theory of Constraints OBJECTIVE Five-Step Method for Improving Performance 1. Identify an organization’s constraints. 2. Exploit the binding constraints. 3. Subordinate everything else to the decisions made in Step 2. 4. Elevate the organization’s binding constraints. 5. Repeat the process as a new constraint emerges to limit output.

  29. 4 Theory of Constraints OBJECTIVE Continued from left Drum-Buffer-Rope System: General Description Continued

  30. 4 Theory of Constraints OBJECTIVE Drum-Buffer-Rope System: Schaller Company

  31. 4 Theory of Constraints OBJECTIVE New Constraint Set: Schaller Company

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