CHAPTER 4

Vehicle parts, supply

management and
budget

1
INTRODUCTION

 Definition of spare parts

 In order to understand the problems of spares,
let us first define spare parts. In Chamber’s
Twentieth Century Dictionary, a spare part is
defined as “a part of a machine ready to
replace an identical part of it, if it becomes
faulty”.

 The import trade control defines spare parts

as follows: “Spare parts are those parts of
machines which because of wear and tear,
use, or breakage, need replacement”.

 We can define spare parts as parts identical to

the part of a machine which need replacement
due to wear and tear during the operating life
of the equipment. 2
CONTD. INTRODUCTION
 Spare parts may look small and appear cheaper
than the machine or raw material, but they play
a vital role in maintaining, ensuring and
reinforcing the reliability of any equipment.

 Spare parts include materials such as (a) pipes,

tubes, springs, electrical cables, knobs, wires,
hoses, beltings, (b) sub-assemblies of essential
parts of the machines like engines, motors,
compressors, and alternators, and (c) complete
units which are to be fitted with a machine,
e.g. water circulating pumps, motors, panels,
controls, bolts and gears.

 Items such as plates, sheets, rods, strips, etc.

which have to be fabricated for manufacturing
complete units are not treated as spare parts.
3
 SPECIAL FEATURES OF SPARES
 The features peculiar to spare parts which
distinguish them from other materials are:

(a) Their requirement is very small.

(b) There is excessive stock in all positions
of the distribution channels.

(c) Their requirements are uncertain.

(d) They are uneconomical to manufacture

as their demand is uncertain and small.

(e)They have a high tendency for

obsolescence.
4
SPECIAL FEATURE…
(f) It is difficult to forecast future
requirements.
(g) Lead time is long.
(h) It is difficult to get failure data.
(i) There is lack of information
system.
(j) Number of suppliers is smaller.
(k) Use of supplier’s part number is
common instead of
internal codification.
(l) Inspection is not always easy as
testing facilities are not
readily available. 5
 CATEGORIZATION OF SPARES

 Organizations classify spares in a variety of

ways like regular, fast moving, emergency,
consumables, major, minor, moving, non-
moving, electrical, obsolete, mechanical,
instruments, proprietary, permissible, and
project spares.

 But spare parts must be classified as

maintenance,overhauling,commissioning,
rotable, insurance, and capital spares for
introducing scientific controls.

6
CONTD. CATEGORIZA…
 Maintenance spares are those which
are fast moving like bearings, belts,
and hardware items. Normally, these
are available in plenty and the spare
parts can be stocked after building a
database on the consumption pattern.

 Overhauling spares are those which

are specially needed during regular
overhauls in order to give a new lease
of life to the equipment. Hence, these
need not be stocked but ordered just
in time before overhauling.
7
CONTD. CATEGORIZATION…
 Commissioning spares are needed to start a project or
commission an equipment and these parts are declared
as project surplus after the machine starts its
operation. Costly assemblies like motors, engines, and
pumps are repaired and stored for use.

 Rotable spares are those which are used in rotation

replacing the previous ones; For example, if the engine
of a bus breaks down, it can be removed for repairs and
the bus can be refitted with another good engine from
the stores. This rotation process gives the spares
assembly the name of rotable spares or floats, and
these have to be tackled separately.

 Insurance spares are those vital parts of a machine,

which have life nearly equal to that of a machine itself
and are held as a standby against any breakdowns.
These standby units have a high reliability of
performance and can be capitalized.

8
 COST CONSIDERATION

 There are a large number of factors

that affect the spare parts costs in
any organization. Location of a plant
is a key influencing parameter on
spare part policies.

 If a factory or the using point is

located in a backward area or far
away from industrial centers,
airports, national highways, railway
lines and seaports, then it is bound
to carry more stocks to account for
transportation, and communication
bottlenecks. 9
CONTD. COST CONSID…
 Another aspect of unavoidable delay
is the government regulations on
imports, foreign currency, customs,
and other taxation policies.

 The sophisticated nature of industry,

degree of automation and high-tech
nature of the firm are important
influencing factors as a highly
mechanized automated plant is
sensitive to breakdown of
components in the production
system.
10
CHOICE OF EQUIPMENTS
 In choosing the equipment, the user
must get adequate guidance from the
manufacturer regarding maintenance
problems and spares support.

 The supplier should guarantee

adequate spares for a specified time,
and sufficient notice must be given if
the supply has to be discontinued. He
should provide all technical details
covering maintenance manuals, spares
catalogue, failure data, reliability
information, drawing for critical items,
etc.
11
CONTD. CHOICE OF EQ…
 Before purchasing new equipments,
compatibility with the existing
machineries must be considered from
the spares point of view. At the time of
initial provisioning, the user should
ensure that he is not dumped with
unwanted spares.

 The recommended list of the supplier

must be scrutinized after assessing
factors like stress, strain, and wear and
tear. Based on the number of equipments
sold, the supplier must anticipate the
user’s spares requirement by means of a
good feedback information system. 12
PURCHASING

 In any industry purchase means

buying of equipments, materials,
tools, parts etc. required for
industry.

 The basic objective of the

purchasing function is to ensure
continuity of supply of raw
materials, and spare parts.

13
CONTD. PURCHASING
 The objectives of the purchasing
department can be outlined as under:

 1. To avail the materials, suppliers and

equipments at the minimum possible costs:
These are the inputs in the manufacturing
operations. The minimization of the input
cost increases the productivity and as a
result the profitability of the operations.

 2. To ensure the continuous flow of properly

maintained vehicles: This can be done
through continuous supply of raw materials,
components, tools etc. with repair and
maintenance service.
14
CONTD. PURCHASING

 3. To develop an alternative source of supply:

Exploration of alternative sources of supply of
materials increases the bargaining ability of the
buyer, minimisation of cost of materials and increases
the ability to meet the emergencies.

 4. To establish and maintain the good relations with

the suppliers: Maintenance of good relations with the
supplier helps in evolving a favorable image in the
business circles. Such relations are beneficial to the
buyer in terms of changing the reasonable price,
preferential allocation of material in case of material
shortages, etc.

 5. To train and develop the personnel: Purchasing

department is manned with varied types of personnel.
The company should try to build the imaginative
employee force through training and development.
15
 CONTD. PURCHASING
 6. Efficient record keeping and
management reporting: Paper
processing is inherent in the purchase
function. Such paper processing should
be standardized so that record keeping
can be facilitated.

 Periodic reporting to the management

about the purchase activities justifies
the independent existence of the
department.

16
CONTD. PURCHASING
 7. To achieve maximum integration with
other department of the company:
 The purchase function is related with,

 Engineering department for the purchase of

tools, equipments and machines;

 Financial department for the purpose of

maintaining levels of materials and
estimating the working capital required;

 Personnel department for the purpose of

manning and developing the personnel of
purchase department and maintaining good
vendor relationship.
17
PARAMETERS OF PURCHASING
 The success of any maintenance activity is
largely dependent on the procurement of raw
materials of

1) right quality,
2) in the right quantities,
3) from right source,
4) at the right time and
5) at right price.

 These are described as the basic principles of

purchasing.

 There are other well known parameters such as

right contractual terms, right material, right
place, right mode of transportation and right
attitude are also considered for purchasing. 18
SELECTION OF SUPPLIERS
 Selection of the right supplier is the
responsibility of the purchase
department.

 Following factors are considered for the

selection of suppliers :
A. Sources of supplier
 The best buying is possible only when
the decision maker is familiar with all
possible sources of supply and their
respective terms and conditions.

 The purchase department should try to

locate the appropriate sources of the
supplier of various types of materials. 19
 CONTD. SELECTION OF…
B. Development of approved list of suppliers
 The survey stage (From The buyer’s guide or purchase handbook,
Advertisements in dailies, Trade fair exhibitions etc) highlights the
existence of the source. A business inquiry is made
with the appropriate supplier.

 Here a short listing is made out of the given sources

of suppliers in terms of Maintenance facilities and
capacity, financial standing, product quality,
possibility of timely supply, technical competence,
manufacturing efficiency, general business policies
followed, standing in the industry, competitive
attitude, and interest in buying orders etc.

C. Evaluation and selection of the supplier

 The purchase policy and procedure differ according to
the type of items to be purchased. Hence, evaluation
and selection of the supplier differ accordingly.
20
CONTD. SELECTION OF…
 The following variables are to be considered while
evaluating the quotations of the suppliers:

1. Cost Factors

 Price, transportation cost, installation cost if any,

tooling and other operations cost, incidence of sales
tax and excise duty, terms of payment and cash
discount are considered in cost factor.

2. Delivery

 Routing and Free on board (F.O.B.) terms (Term of sale under

which the price invoiced or quoted by a seller includes all charges up to placing the goods
are important
on boards a ship at the port of departure specified by the buyer.)
in determining the point at which the title to the goods
passes from vendor to the buyer and the responsibility
for the payment of the payment charges. 21
CONTD. SELECTION OF…
3. Design and Specification Factors
 Specification compliance,
specification deviations, specification
advantages, important dimensions and
weights are considered in line with the
demonstration of sample, experience
of other users, after sale services etc.

4. Legal Factors
 Legal factors include warranty,
cancellation provision, patent
protection, public liability, federal laws
and reputation compliance.
22
CONTD. SELECTION OF…
5. Vendor Rating
 The evaluation of supplier or vendor rating provides
valuable information which help in improving the
quality of the decision.

 In the vendor rating three basic aspects are

considered namely quality, service and price. How
much weight should be given to each of these
factors is a matter of judgment and is decided
according to the specific need of the organization.

 Quality would be the main consideration in the

manufacturing of the electrical equipments while
price would be the prime consideration in the
product having a tense competitive market and for
a company procuring its requirements under the
blanket contract with agreed price, the supplier
rating would be done on the basis of two variables
namely quality and delivery. 23
 VENDER RATING ILLUSTRATIONS
 ILLUSTRATION 1 : The following information is available
on 3 vendors: A, B and C. Using the data below,
determine the best source of supply under weighed-
point method and substantiate your solution.
 Vendor A: Delivered ‘56’ lots, ‘3’ were rejected, ‘2’ were
not according to the schedule.
 Vendor B: Supplied ‘38’ lots, ‘2’ were rejected, ‘3’ were
late.
 Vendor C: Finished ‘42’ lots, ‘4’ were defective, ‘5’ were
delayed deliveries.
 Give 40 for quality and 30 weightage for service.
Solution: Formula: Quality performance:

Delivery performance:
Y : Adherence to time schedule (weightage 30%)

24
CONTD. VENDER RATING…
Or
 Y : Adherence to quantity schedule (weightage 30%)

Vendor ‘A’ is selected with the best rating.

25
 CONTD. VENDER RATING…
 ILLUSTRATION 2 : The following information is available
from the record of the incoming material department of ABC
Co. Ltd.

The factor weightage for Quality, Delivery and Price (QDP) are 40%,
35% and 25% as per the decision. Rank the performance of the
vendors on the QDP basis and interpret the result.
Solution: Formula:
Total vendor rating = Quality performance + Delivery performance
rating + Price rating; Formal mode:

26
CONTD. VENDER RATING…

Vendor B is selected with higher rating.

27
STORES MANAGEMENT
 The most important purpose served by the stores
is to provide uninterrupted service to the
maintenance and repair divisions. Further, stores
are often equated directly with money, as money
is locked up in the stores.
FUNCTIONS OF STORES
The functions of stores can be classified as follows:
 1. To receive raw materials, components, tools,
equipment’s and other items and account for
them.

 2. To provide adequate and proper storage and

preservation to the various items.

 3. To meet the demands of the consuming

departments by proper issues and account for the
consumption.
28
CONTD. STORES MANAGEMENT

 4. To minimise obsolescence, surplus and scrap

through proper codification, preservation and
handling.

 5. To highlight stock accumulation,

discrepancies and abnormal consumption and
effect control measures.

 6. To ensure good house keeping so that

material handling, material preservation,
stocking, receipt and issue can be done
adequately.

 7. To assist in verification and provide

supporting information for effective purchase
action. 29
CONTD. STORES MANAGEMENT
Codification
 It is one of the functions of stores
management. Codification is a process of
representing each item by a number, the
digit of which indicates the group, the
sub-group, the type and the dimension of
the item.
 Many organizations in the public and
private sectors have their own system of
codification, varying from eight to
thirteen digits.
 The first two digits represents the major
groups, such as raw materials, spare
parts, sub-contracted items, hardware
items, packing material, tools, oil,
stationery etc.
30
CONTD. STORES MANAGEMENT
 The next two digits indicate the sub-groups,
such as, ferrous, non-ferrous etc.; Dimensional
characteristics of length, width, head diameter
etc. constitute further three digits and the last
digit is reserved for minor variations.

 Whatever may be the basis, each code should

uniquely represent one item. It should be simple
and capable of being understood by all.
Codification should be compact, concise,
consistent and flexible enough to accommodate
new items.

 The groupings should be logical, holding similar

parts near to one another. Each digit must be
significant enough to represent some
characteristic of the item.

31
CONTD. STORES MANAGEMENT
Objectives of Codification
The objectives of a rationalized material coding system
are:

 1. Bringing all items together.

 2. To enable putting up of any future item in its proper
place.
 3. To classify an item according to its characteristics.
 4. To give a unique code number to each item to avoid
duplication and ambiguity.
 5. To reveal excessive variety and promote
standardization and variety reduction.
 6. To establish a common language for the
identification of an item.
 7. To fix essential parameters for specifying an item.
 8. To specify item as per national and international
standards.
 9. To enable data processing and analysis.
32
CONTD. STORES MANAGEMENT
Advantages of Codification
 As a result of rationalized codification, many
firms have reduced the number of items. It
enables systematic grouping of similar items
and avoids confusion caused by long
description of items since standardization of
names is achieved through codification, it
serves as the starting point of simplification
and standardization.

 It helps in avoiding duplication of items and

results in the minimisation of the number of
items, leading to accurate record.

 Codification enables easy recognition of an

item in stores, thereby reducing clerical
efforts to the minimum. 33
 Inventory management
Meaning of Inventory

 Inventory, sometimes known as stock,

refers to idle goods or materials that are
held by an organization for use sometime
in the future. Items carried in inventory
can be:
• raw materials
• purchased parts
• components
• subassemblies
• work-in-process
• finished goods
• and supplies
34
CONTD. INVENTORY…

Reasons for Keeping Inventories

 1. To stabilize maintenance program:
The demand for an item fluctuates
because of the number of factors, e.g.,
seasonality, maintenance schedule
etc.; The inventories (raw materials
and components) should be made
available to maintenance as per the
demand;

 Failing results in stock out and fleet

downtime due to lack of materials.
Hence, the inventory is kept to take
care of this fluctuation so that the
fleet (vehicle) is smooth. 35
CONTD. INVENTORY…
 2. To take advantage of price discounts:
Usually the manufacturers offer discount
for bulk buying and to gain this price
advantage the materials are bought in bulk
even though it is not required immediately.
Thus, inventory is maintained to gain
economy in purchasing.

 3. To meet the demand during the

replenishment period: The lead time for
procurement of materials depends upon
many factors like location of the source,
demand supply condition, etc.; So inventory
is maintained to meet the demand during
the procurement (replenishment) period.
36
INVENTORY ANALYSIS AND SELECTIVE CONTROL
 For the successful spare parts
management, it is essential to analyze the
spare parts inventory based on various
characteristics such as the frequency of
issues, the annual consumption value, the
criticality, the lead time and the unit price.

 Commonly used inventory analyses are:

(1) FSN Analysis

(2) ABC Analysis
(3) VED Analysis
(4) SDE Analysis
(5) HML Analysis
37
 CONTD. INVENTORY ANALYSIS…

 FSN Analysis : Classification based on Frequency of

Issues/Use;

 F, S & N stand for Fast moving, Slow moving and

Non moving items respectively. This form of
classification identifies the items frequently issued,
less frequently issued for use and the items which
are not issued for longer period, say, 2 years. For
instance, the items can be classified as follows:

 Fast Moving (F) = Items that are frequently issued

say more than once a month.

 Slow Moving (S) = Items that are issued once a

month.

 Non-Moving (N) = Items that are not issued\used for

more than 2 years.
38
CONTD. INVENTORY ANALYSIS…

 This classification helps spare parts management

in establishing most suitable stores layout by
locating all the fast moving items near the
dispensing window to reduce the handling efforts.

 Also, attention of the management is focused on

the Non-Moving items to enable decision as to
whether they are required in the future or they can
be salvaged. Experience shows that many
industries which are more than 15 years old have
more than 50% of the stock as non-moving spares.

 Even if a few of them are disposed off and the

locked up capital is made available, it will make
available additional working capital to the
organization. Action for disposal should be taken
based on the value of each item of spare.
39
CONTD. INVENTORY ANALYSIS…
 SDE Analysis: Classification based on the lead time;

 This classification is carried out based on the lead time

required to procure the spare part. The classification is
as follows:

 Scarce (S) : Items which are imported and those items

which require more than 6 months' lead time.

 Difficult (D) : Items which require more than a fortnight

(Or two weeks) but less than 6 months' lead time.

 Easily available (E) : Items which are easily available

ie., less than a fortnights' lead time.

 This classification helps in reducing the lead time

required at least in case of vital items. Ultimately, this
will reduce stock-out costs in case of stock-outs.

40
 CONTD. INVENTORY ANALYSIS…
 VED Analysis: Classification Based On Criticality;

 Several factors contribute to the criticality of a spare

part. If a spare is for a machine on which many other
processes depend, it could be of very vital importance.

 Also if a spare is, say, an imported component for which

procurement lead time could be very high its non-
availability may mean a heavy loss.

 Similarly spares required for fighter aircraft at the time

of war could be of great value in terms of fighting
capability.
 In general, criticality of a spare part can be determined
from the maintenance downtime loss, due to spare
being not available when required.
 Based on criticality, spare parts are conventionally
classified into three classes, viz. Vital, Essential and
Desirable (VED).
41
CONTD. INVENTORY ANALYSIS…
 VITAL (V) : A spare part will be termed vital, if on account of
its non-availability there will be very high loss due to
maintenance downtime and/or a very high cost will be
involved if the part is procured on emergency basis. In a
process industry, most spare parts for the bottleneck
machine or process will be of vital nature. For example,
bearings for a kiln (large oven for baking clay and bricks) in a cement
plant will be considered vital.

 ESSENTIAL (E) : A spare part will be considered essential if,

due to its non-availability, moderate loss is incurred. For
example, bearings for motors of auxiliary pumps will be
classified as essential.

 DESIRABLE (D) : A spare part will be desirable if the

maintenance service loss is not very significant due to its
non-availability. Most of the parts will fall under this
category. For example, gaskets for piping connection.

 The VED analysis helps in focusing the attention of the

management on vital items and ensuring their availability by
frequent review and reporting. Thus, the downtime losses
could be minimized to a considerable extent.
42
CONTD. INVENTORY ANALYSIS…
 ABC Analysis: Classification Based on Consumption;
 Another method of classifying spares is on the basis of
annual consumption value. As it is true for any inventory
situation, Pareto's principle can be applied to classify
maintenance spares based on consumption value.

 Pareto principle : The significant items in a given group

normally constitute a small portion of the total items in
a group and the majority of the items in the total will, in
aggregate (a total number collected together), be of minor
significance.

 This way of classification is known as ABC

classification.
 CLASS A: 10% of total spares contributing towards 70%
of total consumption value.
 CLASS B: 20% of total spares which account for about
20% of total consumption value.
 CLASS C: 70% of total spares which account for only
10% of total consumption value.
43
CONTD. INVENTORY ANALYSIS…
 In a specific spares control system, it is quite possible that in a
single year, many spares would not have been consumed at all.
 In such cases, it is better to perform ABC analysis on longer
consumption period data, say 3 years. Once ABC classification
has been achieved, the policy control can be formulated as
follows:

 Policy for 'A' items

* Maximum control
* Value Analysis
* More than one supplier
* Control by top executives.

 Policy for 'B' items

* Minimum control
* Bulk Orders
* More items from same supplier

 Policy for ‘C’ Items:

The items being of low value, the control can be exercised at
grass root level of authority, i.e., by respective user department
managers. 44
CONTD. INVENTORY ANALYSIS…
 HML Analysis: Classification based on unit price;
 This classification is as follows:
 High Cost (H) : Item whose unit value is very high,
say, Br.1000/- and above.
 Medium Cost (M) : Item whose unit value is of medium
value, say, above Br.100/- but less than Br.1000/-.
 Low Cost (L) : Item whose unit value is low,
say, less than Br.100/-.

 This type of analysis helps in exercising control at the

shop floor level ie, at the use point. Proper
authorization should be there for replacing a high
value spare.

 Efforts may be necessary to find out the means for

prolonging the life of high value parts through
reconditioning and repair. Also, it may be worthwhile
to apply the techniques of value analysis to find out a
less expensive substitute.
45
INVENTORY CONTROL SYSTEMS
 Introduction
 To ensure smooth functioning it is essential to
develop a suitable inventory control by which
optimization of spare parts cost is achieved in a
systematic way.

 As regards the fast moving and slow moving items

are concerned, the following procedure can be
followed taking into consideration various cost
elements.

 While managing the spare-parts inventory, basically

there are four cost elements to be considered:-
1. Cost of the spare part
2. Cost of ordering
3. Cost of storage
4. Cost of stock-out.
46
CONTD. INVENTORY CONT…

1) Cost of the spare part (purchasing

cost) can be defined as the quoted price
of inventory minus any discounts
allowed plus shipping charges.

 purchasing cost becomes an important

factor when the spare parts unit price
becomes dependent on the size of the
order. This situation is normally
expressed in terms of a quantity
discount or a price break, where the
unit price of the item decreases with
the increase of the ordered quantity.
47
CONTD. INVENTORY CONT…

2) Cost of ordering includes:

1. Rent for purchase department

2. Depreciation for Office facilities
3. Salaries
4. Postage & Telephone expenses
5. Stationery expenses
6. Travel expenses
7. Incoming Inspection
8. Entertainment & Misc.
expenses.
48
CONTD. INVENTORY CONT…
3) Cost of storage includes

1. Rent for the stores

2. Depreciation on storage and
handling facilities
3. Handling charges
4. Salaries of stores staff and
clerks
5. Taxes
6. Insurance
7. Costs of stationery etc.

49
CONTD. INVENTORY CONT…
4) Cost of stock-out
The components of the stockout cost
are as follows:

(a) Profit lost due to lost sales which in

turn is due to production loss as the
part is not available.

(b) Loss of goodwill of the customer and

future sales due to his switching over to
another supplier wherever possible.

(c) Penalties for late deliveries.

50
CONTD. INVENTORY CONT…
(d) The down time of the equipment and low
morale of workers.

(e) Waste of products preceding, during,

and following condition after repair.

(f) Cost of bringing back equipment to

working condition after repair.

(g) Additional price/transportation

charges to get the spares.

(h) Interest burden on investment on

equipment which is lying idle due to
want of spares. 51
INVENTORY MODEL

 Inventory models deal with idle resources

like men, machines, money and materials.
These models are concerned with two
decisions: how much to order (purchase or
produce) and when to order so as to
minimize the total cost.

 For the first decision - how much to order,

there are two basic costs which are to be
considered namely, inventory carrying
costs and the ordering or acquisition costs.
As the quantity ordered is increased, the
inventory carrying cost increases while the
ordering cost decreases.
52
CONTD. INVENTORY MODEL
 The ‘order quantity’ means the quantity
produced or procured during one operation
(production) cycle. Economic order quantity
is calculated by balancing the two costs.

Economic Order Quantity (EOQ)

 Economic Order Quantity (EOQ) is that size

of order which minimizes total costs of
carrying and cost of ordering. i.e., Minimum
Total Cost occurs when Inventory Carrying
Cost = Ordering Cost. Economic order
quantity can be determined by two methods:
1. Tabulation method.
2. Algebraic method.
53
CONTD. INVENTORY MODEL…

 Before calculating economic order

quantity it is necessary to become
familiar with terms like maximum
inventory, minimum inventory,
standard order and reorder point,
which are known as Quantity
Standards.

54
CONTD. INVENTORY MODEL…
 Maximum Quantity OA is the
upper or maximum limit to
which the inventory can be
kept in the stores at any time.

 Minimum Quantity OE is the

lower or minimum limit of the
inventory which must be kept
in the stores at any time.

55
CONTD. INVENTORY MODEL…
 Standard Order. (A’D) is the
difference between maximum and
minimum quantity and it is known
as economical purchase inventory
size.

 Reorder Point (B) indicates that it is

high time to initiate a purchase
order and if not done so the
inventory may exhaust, and even
reserve stock utilized before the
new material arrives.
56
CONTD. INVENTORY MODEL…
 Figure 4 shows different quantity
standards.

 Starting from an instant when

inventory OA is in the stores, it
(inventory) consumes gradually in
quantity from A along AD at a
uniform rate.

 It is pre-known that it takes L

number of days between initiating
order and receiving the required
inventory.
57
CONTD. INVENTORY MODEL…

58
CONTD. INVENTORY MODEL…
 Therefore as the quantity reaches
point B, purchase requisition is
initiated which takes from B to C, that
is time R.

 From C to D is the inventory

procurement time P.

 At the point D when only reserve

stock is left, the ordered material is
supposed to reach and again the total
quantity shoots to its maximum value,
i.e. the point A’ (A=A’).
59
 CONTD. INVENTORY MODEL…
 From B’ to D’ it is a lead time (L) and it
may be calculated on the basis of past
experience. It includes:

(a) time to prepare purchase requisition

and placing the order;
(b) time taken to deliver purchase order
to the seller;
(c) time for seller (vendor) to get or
prepare inventory; and
(d) time for the inventory to be dispatched
from the vendor’s end and to reach the
customer.
60
CONTD. INVENTORY MODEL…
 Time, (a) above is known as
requisition time (R).

 Time (b) + (c) + (d) is the

procurement time (P).

 The economic lot size for an order

or the economic order quantity
depends upon two types of costs,
i.e. Inventory procurement cost and
carrying cost.
61
 CONTD. INVENTORY MODEL…
 The purpose of EOQ should be to hold enough
and not excessive stock of material. Stock
holding:

(a) Avoids running out of stock;

(b) Helps creating a buffer stock which may be
utilized if the material falls below the
minimum level;
(c) Makes sure the predecided delivery dates;
(d) Provides quick availability of materials;
(e) Takes care of price fluctuations and
shortage of inventory in the market;
(f) Advises regarding, obsolete and slow
moving items;
(g) Helps in standardization and thus reducing
62
CONTD. INVENTORY MODEL…
(a)Inventory procurement (ordering)
costs, which consist of expenditure
connected with
1. receiving quotations (or costs);
2. processing purchase requisition;
3. following up and expediting
purchase order;
4. receiving material and then
inspecting it; and
5. processing seller’s (vendor’s)
invoice. Procurement costs
decrease as the order quantity
increases (see Fig.5)
63
CONTD. INVENTORY MODEL…
(b) Carrying costs, which vary with
quantity ordered, base on average
inventory and consist of:
1. interest on capital investment;
2. cost of storage facility, up-keep of
material, record keeping etc;
3. cost involving deterioration and
obsolescence and
4. cost of insurance, property tax, etc.

 Carrying costs are almost directly

proportional to the order size or lot size
or order quantity.
64
CONTD. INVENTORY MODEL…

In Fig. 5. the
procurement costs and
inventory carrying costs
have been plotted with
respect to quantity in
lot. Total cost is
calculated by adding
procurement cost and
carrying cost. Total cost
is minimum at the point
A and thus A’
represents the
economic order quantity
or economic lot size.

65
 CONTD. INVENTORY MODEL…
1. Determination of EOQ by Tabulation
(Trial & Error) Method
This method involves the following steps:
1. Select the number of possible lot sizes
to purchase.
2. Determine average inventory carrying
cost for the lot purchased.
3. Determine the total ordering cost for the
orders placed.
4. Determine the total cost for each lot size
chosen which is the summation of
inventory carrying cost and ordering cost.
5. Select the ordering quantity, which
minimizes the total cost.
66
CONTD. INVENTORY MODEL…
 The data calculated in a tabular column can
be plotted showing the nature of total cost,
inventory cost and ordering cost curve
against the quantity ordered as in Fig. 6.

 ILLUSTRATION 1: The XYZ Ltd. carries a

wide assortment of items for its customers.

 One of its popular items has annual demand

of 8000 units. Ordering cost per order is
found to be Br 12.5. The carrying cost of
average inventory is 20% per year and the
cost per unit is Br. 1.00. Determine the
optimal economic quantity and make your
recommendations.
67
CONTD. INVENTORY MODEL…

Fig. 6

68
CONTD. INVENTORY MODEL…

2. Determination of EOQ by Analytical Method

 In order to derive an economic lot size formula following

assumptions are made:
1. Demand is known and uniform.
2. Let D denotes the total number of units
purchased/produced and Q denotes the lot size in
each production run.
3. Shortages are not permitted, i.e., as soon as the
level of the inventory reaches zero, the inventory is
replenished.
4. Production or supply of commodity is instantaneous.
5. Lead-time is zero.
6. Set-up (ordering) cost per production run or
procurement cost is C3.
7. Inventory carrying cost is C1 = CI, where C is the unit
cost and I is called inventory carrying cost expressed
as a percentage of the value of the average
69
CONTD. INVENTORY MODEL…
 The most economic point in terms of total inventory cost
exists where,
 Inventory carrying cost = Annual ordering cost (set-up cost)
 Average inventory = 1/2 (maximum level + minimum level)
= (Q + 0)/2 = Q/2
 Total inventory carrying cost = Average inventory ×
Inventory carrying cost per unit i.e.,
 Total inventory carrying cost = Q/2 × C1 = QC1/2 …(1)

 Total annual ordering costs = Number of orders per year ×

Ordering cost per order i.e.,
 Total annual ordering costs = (D/Q) × C3 = (D/Q)C3 …(2)

 Now, summing up the total inventory carrying cost and the

total ordering cost, we get the total inventory cost C(Q).
 i.e., Total inventory cost (Total cost of production run) =
Total inventory carrying cost + Total annual ordering costs

 C(Q) = QC1/2 + (D/Q)C3 (cost equation) …(3)

70
CONTD. INVENTORY MODEL…
 But, the total cost is minimum when the inventory carrying
costs becomes equal to the total annual ordering costs.
Therefore,
 QC1/2 = (D/Q)C3
 or QC1 = (2D/Q)C3 or Q2 = 2C3D/C1

71
CONTD. INVENTORY MODEL…
 ILLUSTRATION 2: An engine manufacturer
purchases lubricants at the rate of Br 42 per piece
from a vendor. The requirements of these
lubricants are 1800 per year.
 What should be the ordering quantity per order, if
the cost per placement of an order is Br 16 and
inventory carrying charges per Birr per year is 20
cents.
SOLUTION: Given data are:
 Number of lubricants to be purchased, D = 1800
per year
 Procurement cost, C3 = Br 16 per order
 Inventory carrying cost, C1 = CI= Br. 42 × Br. 0.20 = Br
8.40 per year

72
CONTD. INVENTORY MODEL…
 ILLUSTRATION 3: A manufacturing company
purchase 9000 parts of a machine for its annual
requirements ordering for month usage at a time,
each part costs Br 20. The ordering cost per order
is Br 15 and carrying charges are 15% of the
average inventory per year. You have been
assigned to suggest a more economical purchase
policy for the company. What advice you offer and
how much would it save the company per year?

SOLUTION: Given data are:

 Number of parts to be purchased, D = 9000 parts
per year
 Cost of part, C = Br 20

 Procurement cost, C = Br 15 per order

3

 Inventory carrying cost, C1 = CI = C x 15% of the

value of the average inventory per year
= Br 20 × 0.15 = Br 3 per each part per year
73
CONTD. INVENTORY MODEL…

If the company follows the policy of ordering every month, then

the annual ordering cost is = 12 × Br 15 = Br 180

Lot size of inventory each month = 9000/12 = 750

Average inventory at any time = Q/2 = 750/2 = 375
Therefore, storage (inventory carrying) cost at any time
= 375 × C1 = 375 × 3 = Rs. 1125
Total annual cost = 1125 + 180 = Br 1305

Hence, the company should purchase 300 parts at time interval of

1/30 year instead of ordering 750 parts each month. The net
saving of the company will be = Br 1305 – Br 900 = Br 405 per year.
74
 Materials Requirement Planning (MRP)

 Materials Requirement Planning is a time phased

priority-planning technique that calculates material
requirements and schedules supply to meet demand
across all products and parts in one or more plants.

 MRP techniques focus on optimizing inventory. MRP

techniques are used to explode bills of material, to
calculate net material requirements and plan future
production.

 MRP systems use four pieces of information to

determine what material should be ordered and
when :

 the master production schedule, which describes

when each product is scheduled to be manufactured;

75
 Contd. Materials requ…
 bill of materials, which lists exactly the
parts or materials required to make each
product;

 production cycle times and material

needs at each stage of the production
cycle time; and,

 supplier lead times.

o The master schedule and bill of materials
indicate what materials should be
ordered; the master schedule, production
cycle times and supplier lead times then
jointly determine when orders should be
placed. 76
 CONTD. Materials Requirement…
Objectives of MRP
 1. Inventory reduction: MRP determines how
many components are required, when they
are required in order to meet the master
schedule. It helps to procure the materials/
components as and when needed and thus
avoid excessive build up of inventory.

 2. Reduction in the manufacturing and

delivery lead times: MRP identifies materials
and component quantities, timings when
they are needed, availabilities and
procurements and actions required to meet
delivery deadlines. MRP helps to avoid
delays in production and priorities
production activities by putting due dates on
customer job order. 77
 Contd. Materials Requ…
 3. Realistic delivery commitments: By
using MRP, production can give
marketing timely information about
likely delivery times to prospective
customers.

 4. Increased efficiency: MRP provides

a close coordination among various
work centers and hence help to
achieve uninterrupted flow of
materials through the production line.
This increases the efficiency of
production system.
78
 Contd. Materials Requirement…

MRP System

 The inputs to the MRP system are: (1)

A master production schedule, (2) An
inventory status file and (3) Bill of
materials (BOM).

 Using these three information

sources, the MRP processing logic
(computer programme) provides three
kinds of information (output) for each
product component: order release
requirements, order rescheduling and
planned orders. 79
CONTD. MATERIALS REQUIREMENT…

80
 Contd. Materials Requ…
 1. MASTER PRODUCTION SCHEDULE (MPS)
MPS is a series of time phased quantities
for each item that a company produces,
indicating how many are to be produced
and when. MPS is initially developed from
firm customer orders or from forecasts of
demand before MRP system begins to
operate.

 The MRP system translates MPS end items

into specific component requirements.
Many systems make a simulated trial run
to determine whether the proposed master
can be satisfied. 81
 Contd. Materials Requ…
 2. INVENTORY STATUS FILE
Every inventory item being planned must have an
inventory status file which gives complete and up
to date information on the on-hand quantities,
gross requirements, scheduled receipts and
planned order releases for an item. It also includes
planning information such as lot sizes, lead times,
safety stock levels and scrap allowances.

 3. BILL OF MATERIALS (BOM)

BOM identifies how each end product is
manufactured, specifying all subcomponents
items, their sequence of build up, their quantity in
each finished unit and the work centers
performing the build up sequence. This
information is obtained from product design
documents, workflow analysis and other standard
manufacturing information. 82