Note 8

Note 8:
Inventory Management: EOQ, JIT,

and the Theory of Constraints
JUST-IN-TIME
An excellent option for many businesses and circumstances in need of improved inventory
control is just-in-time (JIT) inventory management. It is a contemporary inventory model in
which purchases and production of materials, parts and subcomponents are scheduled so that
items are available just when needed for production, not earlier and not later. There are zero
inventories. While Just-in-case inventory management provides the necessary background for
grasping the advantages of inventory management methods that are used in the contemporary
manufacturing environment. Without monitoring, companies waste money on unneeded
inventory storage facilities and enormous warehouses, as well as on materials and items that are
never utilized or sold.
Setup Costs Stock-out Costs Economic Order Quantity

- These are the costs of - Are the costs of not - It is a mathematical approach
preparing equipment and to compute order size/number
having a product
facilities so they can be used of units to order to minimize the
to produce a particular
available when demanded annual sum of the inventory
product or component. by a customer. carrying cost and ordering cost.
JIT INVENTORY SYSTEM ● The use of KANBAN incorporated in the design of a

computerized manufacturing system it states the quantity that a
succeeding process shall withdraw.
● Many non-JIT companies do not fully implement a JIT system
but they are maintaining an Optimum Level of Inventory to
manage their inventories.
JIC Inventory Management
3 types of inventory costs
the cost of acquiring inventory
the cost of holding inventory
the cost of not having inventory on hand when needed
Relevant Costs of Inventories
Cost of Ordering (These are the costs of placing and Cost of Carrying (These are the costs of holding
receiving an order) inventory)
1. Preparing purchase or production orders 1. Foregone return on capital invested in
2. Receiving (unloading, unpacking, inspecting) inventory
3. Processing all related documents 2. Risk of obsolescence and deterioration
4. Extra costs of numerous small production 3. Storage-space costs
runs, setups and training
4. Personal property taxes on inventory
5. Quantity discounts lost (trade discounts on
5. Insurance on inventory
volume purchases)
INVENTORY CONTROL ADVANTAGES OF JIT

(TWO MAIN QUESTIONS) INVENTORY MANAGEMENT
1. How much to order? → Reduced warehousing. Companies don’t need large
best/optimum size = Economic Order Quantity (EOQ) warehouses when they have less inventory to store,
which dramatically reduces warehousing budgets.
(the point where the total ordering costs is equal to
total carrying cost or total relevant inventory costs → Improved efficiency. Less material overhead leads to
(at the lowest) is equal to ordering costs plus the less waste, and less waste helps companies save money.
carrying costs.)
→ Easier rotating. JIT inventory makes it easier and
2. When to order? less costly for companies to pivot — to new lines,
reorder point – inventory level where a purchase order upgraded products since there aren’t shelves of old
should be placed products that need to be cleared.
Note 8:
Inventory Management: EOQ, JIT,
and the Theory of Constraints
ECONOMIC ORDER QUANTITY
Economic Order Quantity (EOQ) is a calculation used in inventory management to
determine the optimal order quantity that minimizes total inventory holding costs and
ordering costs.
Its goal is to find the balance between the costs associated with holding inventory and the
costs associated with ordering more inventory.
Formula:
Where: Other Formulas:

AD= annual demand in units CCPU= Total Carrying Cost/Average Inventory
AD (P)= annual demand in peso CCPU= Unit cost x CCR
CPO= cost of placing an order Average inventory= Order Size/2
CCR= carrying cost ratio CPO= Total ordering cost/ No.of Orders
CCPU= annual cost of carrying one unit in Total ordering cost= CPO x No. of Orders
a stock per year No.of Orders= AD/ Order Size
Order Size= Average Inventory x 2
REORDER POINT (ROP) SAFETY STOCK

- Inventory level signaling when to place a - Reserved inventory to prevent
purchase order. stockouts due to demand spikes or order
- Calculated as Lead Time Quantity + Safety delays.
Stock Quantity
SAFETY STOCK
LEAD TIME COMPONENTS
- Calculated as normal usage x normal lead In Usage: (Max Usage – Normal Usage) ×
time. Normal Lead Time.
In Time: (Max Lead Time – Normal Lead
THEORY OF CONSTRAINTS Time) × Normal Usage or Average Daily
(TOC) Usage.
Objective: Make money now and in the future
through constraint management. Maximum Inventory Level: Equals Safety
Constraint Definition: Limiting factor in Stock Quantity plus Order Size.
organizational performance; every system has at
least one.
Chain Analogy: Compares organizations to chains
FIVE-STEP METHOD FOR
with the weakest link (constraint). IMPROVING PERFORMANCE:
Identify organization's constraints.
TOC APPROACH: Exploit the binding constraints.
» Focuses on system-level effects for continuous Subordinate everything else to decisions from
improvement.
step 2.
» Strengthening the weakest link improves overall
performance.
Elevate the organization’s binding constraints.
» Identifies constraints, exploits, subordinates, Repeat the process as new constraints emerge,
elevates, and repeats the process. limiting output.

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Note 8:

Inventory Management: EOQ, JIT,

Setup Costs Stock-out Costs Economic Order Quantity

JIT INVENTORY SYSTEM ● The use of KANBAN incorporated in the design of a

Relevant Costs of Inventories

INVENTORY CONTROL ADVANTAGES OF JIT

Where: Other Formulas:

REORDER POINT (ROP) SAFETY STOCK

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