Operations Concept and Economic Order Quantity - Assignment Example

Operations concept Name Course title Tutor Date QUESTION ONE Operations concept Operations concepts refer to the set of functions to be performed for the accomplishment of a certain mission or description of the set of capabilities that are required for an operational system. Operations management concepts are theories developed by experts from different fields and they focus on the subtle routines and activities that can be systemically improved by stages to enhance the processes within an organization. These management concepts use practicality and logic to bring efficiency in operations management (Hilt, 2005). The first concept of operations management is Total Quality Management (TQM). Total quality management is a series of management practices in an organization geared towards the improvement of an organization processes. Total quality management focuses strongly on the processes, the measurements and the controls as a benchmark for continued improvement. Total quality management is, therefore, an approach that many organisations use to improve customer satisfaction and internal processes (Johnson et al, 1997). When total quality management is correctly implemented in an organization, it brings reduction in costs of operations, better performance in processes and increase in customer satisfaction. Total quality management also requires an organization to focus on the cure of its problems rather than just treating the symptoms of problems in its processes (Sadler, 2007). Total quality management also requires the top management of an organization to be the main driver of total quality management and at the same time create an environment that ensures the implementation of total quality management. Total quality management also requires the use of the methodology and the tools to identify areas that are not conforming to the principles of total quality management. Total quality management is, therefore, the management of the initiatives and the procedures directed at delivery of quality products and services by an organization (Hayes & Wheelwright, 1985). The second concept of operations management is inventory management. Inventory management entails the specification of the size and the placement of stocks required for the processes of an organization. Inventory management, therefore, ensures that the stock required at different locations within the supply chain of a business is enough and free of disturbances and balances with demand and the product replenishment times (Johnson et al, 1997). Managing the inventory of a business is one of the most visible and tangible aspects of running a business. Inventory management entails the management of raw materials, good in the process and the finished products or services. Many companies regard inventory as a risk. Inventory management is essential for a business because it eliminates the problem of mismanagement, reduces the cost of raw materials and enhances the decision making process of an organization (Rashid, 2011). If a company does not have good inventory management practices, inventory inefficiencies occur such as, delays in production, additional cost of raw materials and incorrect budgeting practices .These inventory deficiencies have major impacts on a company’s of excellence (Hilt, 2005). Inventory management also improves the storage of goods the distribution of stock. Inventory management, therefore, entails having knowledge of what inputs are there in an organization, how they will be used and the expected results of the finished products. Inventory management involves the overseeing of the constant flow of inputs into an organization and out of the organization. Inventory helps in the design of the delivery systems in an organization and also shortens the lead times of an organization (Rashid, 2011). Example of application of concepts; Total quality management is widely used by many companies around the world to achieve satisfied customers through the delivery of the high quality products and services. The goal of the total quality management can be achieved if only the organisations entirely reform their cultures. Total quality management is just not a phenomenon that happens in big companies .Small companies also apply the principles of total quality management to improve their processes and enhance their overall efficiency (Chase,1998). One company that has applied total quality management in its operations is Penril Datacomm. This company based in Maryland designs data communication equipment. Before the company embraced total quality management, the defects rates of the companies products was so high that the company was scrapping or reworking a third of all equipment it made (Chase, 1998). After the company embraced the principles of total quality management, in the first three months, the company was able to reduce the defects in its data communication equipment by eighty one percent. The company was also able to reduce the number of first year repairs by 73 percent. Total quality management is credited with taking Penril; Datacomm to move from the brink of disaster to period of good health. Total quality management can, therefore, be applied by companies to remove inefficiencies and defects in its production processes and in improvement of efficiency (Chase, 1998). The main managerial tasks that a company can do in implementing total quality management to reduce the defects in its production processes include the identification and evaluation of the areas in the production unit to eliminate all the areas that might lead to flaws in the final product. Other managerial operations that might be done include ensuring that all the stock that is required at all the different locations of the production chain in an organization is available and checking the adherence to the accepted standards of the processes of the company. QUESTION 2 Economic order quantity. (EOQ) Economic Order Quantity (EOQ) is the quantity that limits holding and the cost of ordering for a whole year. It is based on assumptions, but although these assumptions do not hold they are indicators of how reasonable the current orders quantities are (Bozarth, 2011). It is usually a nightmare for businesses to determine the quantity of inventory that will be ordered at a given time. Many economists have come up with formulas and algorithms, but the simplest and most relied upon is the EOQ. As explained, this model uses unrealistic assumptions. Regardless of these unrealistic assumptions, prominent corporations use this model. This model is mainly employed with independent demand inventory like spare parts and paper. This is because the assumptions of this model are simplistic and not applicable in real life and hence cannot be used with depended demand inventory. According to Bozarth, (2011), one of the assumptions made with EOQ are that one item in the business is managed at a time. This model also assumes that the annual demand (D) is constant over time and it is known. The EOQ will also assume that there is no stock out (!) in the business, and, therefore, no stock out cost. The assumption that the unit ordering cost (O) is flat and known throughout the year. The EOQ model assumes that the inventory carrying cost (C) is tied directly to the value of the inventory and remains flat throughout. It is assumed still that the carrying cost is a rate (t %) of the total inventory price. This model also assumes that there is a known and constant delivery leadtime. Finally, this model assumes that there is no quantity discount. These assumptions are unrealistic in real life, but applicable in inventory management for businesses which are concerned about their stock over time (Bozarth, 2011). The inventory management has two aspects; how much to order and how often to order the inventory. Reorder point and safety stock are involved in the determination of how often to order inventory (Charles, 2005). The re-order point directs the management in determination of when incase of a manufacturing company to begin production or when in case of a business to place an order. Three factors affect the reorder point and these are the economic order quantity, leadtime and the usage rate of the stock during the leadtime. Leadtime is the difference in time between placing an order and the time the inventory arrives from the supplier or the production line. If there is a constant stock usage during the lead time, then the following formulae will be used in calculating the reorder point. Reorder point = Average constant usage (weekly or daily) * Lead time (Charles, 2005). Example If the economic order, of a company X is 600 units and the lead time is 3 weeks, and the constant usage per week is 60 units. Reorder point = 60 units * 3 weeks = 180 units This shows that whe3n the inventory drops to the level of 180 the company places an order of 600 units. Safety stock is a buffer that guards organizations against problems associated with demand processing of orders or delivery of required inventory. Safety stock is determined by deducting the average usage per unit time from the maximum usage per unit time Example of company X faced with variable demand it will compute its safety stock as follows: Maximum expected usage per week……………………………. 90 Average usage ……………………………………………………………… 70 units a week Excess…………………………………………………………………………… 20 units Lead time………………………………………………………………………. X 4 weeks Safety stock……………………………………………………………………. 80 units Safety stock is the insurance against the problems of ordering and delivery and demands greater usual. This is why it is important to include safety stock calculations in the inventory management. Incorporated in the EOQ, the safety stock will ensure in the calculation of when and how to order there is the factor of a stock limit to sustain demand and supply levels within the business. According to James (1996), the Economic Oder Quantity has been used for the last 7 decades. Those times it was referred to as the Minimum Cost Quantity. This method was tedious, and time consuming having to calculate every item independently. It later with time came to be known as the Economic Order Quantity with more adjustments made to ease the calculations. Today this module is not widely used. Some few organizations use it, but while hiding due to how this module is deemed unsophisticated. The reason why the EOQ module is not widely used today is that organizations fear inaccuracy associated with data input. The advancement in Information Technology and hence the development of advanced computing software has changed the perception of the business managers. Almost all the ERP packages have inbuilt automatic computation formula for EOQ. This has made the process of inventory ordering and record keeping easier. The latest software used for computation in inventory ordering is referred to as Goods Order Inventory System (GOIS). This is an application for businesses to manage and keep track of their inventory and sales. It has a lot of reporting in terms of inventory supplied, inventory at hand and that which is sold. This is a stand alone application that runs on SQLite database and acts to store all data (James, 1996). QUESTION 3 The role of the inventory planning, and development in any business is the basic achievement of the optimal investment in terms of capital. No business will be interested in inventory investments that are not profitable. The optimal way of reducing the cost of ordering inventory is the EOQ. This module has variables which are; the cost holding one unit inventory for a year (C), the fixed cost to place a single order (F), and the demand for the whole year (D). The ordering cost is all the incurred cost at the process of purchasing. The holding cost is the cost of storage per year is the carrying cost which at times in form of rates of the total amount. EOQ = (2FD/C) ⅟2 Christie should formulate a borrowing policy that will cut on almost all costs, and be effective in maintaining the company in the business despite the looming competition. This policy will be based on the EOQ module and formulated putting into consideration all the costs. In this case, the demand for borrowing per year is $ 17,000 x 305 days = $ 5185000 The fixed cost for placing the order of one unit for one year is $ 17000 * 0.09 = $ 2,730 The cot for holding one unit inventory for a year $ 17000 * 0.0225 = $ 382.5 + $ 1200 = $ 1582.5 EOQ = (2 x 5185000 x 2730/1582.5) ⅟2 = $ 4230 Therefore, the total number of annual orders that Chritie can now be calculated D/EOQ = $ 5185000/4230 = 1225 The total cost of inventory = Ordering cost + Cost of Carrying = C x (EOQ/2) + O x (D/EOQ) = ($ 1582) (4230/2) + ($ 2730) ($ 5185000/4230) 3345930 + 3346347 = $ 6692277 Christie’s borrowing policy based on the above calculations should be structured as below; The business should have at least $ 4230 before borrowing again from the bank. This is the safety stock. This will enable business sustainability by ensuring that the customers do not lose confidence with the business. The business will make 1225 borrowings from the bank in the whole year. The optimal borrowing will amount to $ 6692277 the whole year. Therefore, this policy is the most economical. In order to ensure that the Christie does no face shortages in terms of cash in her business, she has to ensure her borrowing policy includes the dimension of when to borrow. This requires the computation of the reorder point. This guides the business on when to place an order, and it requires knowledge of the lead time. The lead time is that duration between placing an order and receiving the supplies. The calculation of the reorder point for Christie’s company Calculate for the lead time demand by multiplication between the average daily or weekly lead time by the lead time in days. The addition of the safety stock is necessary to bring out the exact variation in the lead time demand. In this case, the calculation of lead time demand is not necessary since the lad time and the average demand are certain. Reorder point = (average demand/lead time unit x lead time) + safety stock The average daily demand is $17,000 and the time lead is 15 days. Therefore; The reorder point = ($ 17000/15 days) x 1 day= $ 1133 + $ 4230 = $ 5362 When the money drops below 5362 Christie should consider borrowing so that by the time the bank processes the loan in 15 days the company does not run below the safety stock .Therefore, the company remains competitive. For example, the figure 1 below represents a company X with EOQ of 400 and reorder point of 128 Adopted from (Hilt, 2005) Christie has been offered by the bank a quantity discount. The quantity discounts are reductions in rates which are offered to borrowers to induce large amount in borrowing. In this case, Christie must consider the benefits of borrowing in large amounts against the carrying costs associated with the large borrowings. This decision will be based on the calculation the quantity that will reduce the total cost of carrying, ordering and product cost. Total cost = the Ordering cost + Product cost + Carrying cost Where P is the price per unit, and Q is the order quantity In this case of Christie the carrying cost is not constant, but a percentage of the borrowed amount. So each curve will have a different EOQ. First, calculate the EOQ for each amount of loan as per the percentage. Then secondly calculate the feasible EOQs. Lastly, there is the selection of value of Q that will yield the lowest total cost. Borrowing quantity (Q) Price per unit (P) $ 1 - $ 499 $ 16617.5 $ 500 and above $ 16660.0 The company should develop an estimate of D = $ 5185000 S = $ 17000 per borrowing and C = 2.0% of the prices per unit. EOQ16617.5 =  = $ 2303.1 EOQ16660.0 =  $ 2300.0 The two borrowing quantities are feasible, but considering the cost of carrying associated with Christie’s loan, one realizes that it is better to ignore the discount and borrow in small quantities. This will attract less carrying cost in terms of the bank’s interest rates. These rates cannot be in any way be compensated by the quantity discount allowed. Large scale borrowing has disadvantages and advantages. The lower amount a business borrows the lower the borrowing cost, the less the stock out and the lower the interest rates. This works to the advantage of the business. With huge borrowing the interest rates are high. This works to the disadvantage of the business. A business, therefore, should formulate an effective methodology in borrowing and borrowing policy. This will ensure high profits as a result of cutting on cost. References Bozarth, C., (2011) Economic Order Quantity (EOQ) Model: Inventory Management Models. 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