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Inventory Management

CHAPTER

10

Inventory Management
Prepared by: DANTE V. ARIEZ MBA

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Inventory Management

Learning Objectives
When you complete this chapter you should be able to: 1. Identify the components of inventory and its related terms; 2. Identify the various forms and documents used to evidence an inventory account 3. Check the importance of human resources who handle the inventory 4. Methods of costing an inventory; and 5. Describe the EOQ model

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Inventory Management

RECEIVABLE

CASH

INVENTORY

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Inventory Management

The operating cycle says that the moment the company has cash; ordinarily they have to convert it into inventory When they have the inventory, they are going to sell and convert the inventory into a receivable and then they will collect the account to eventually convert it back to cash.

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Inventory Management

Inventory: a stock or store of goods

Independent Demand

Dependent Demand

B(4)

C(2)

D(2)

E(1)

D(3)

F(2)

Independent demand is uncertain. Dependent demand is certain.

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Inventory Management

Inventory Models

Independent demand finished goods, items that are ready to be sold

E.g. a computer

Dependent demand components of finished products

E.g. parts that make up the computer

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Types of Inventories

Inventory Management

Raw materials & purchased parts

These are thee materials, which the company purchased and is for use in the production

Partially completed goods called work in progress

These are the partially finished products at the end of the month
These are products already finished, ready to be sold to customers

Finished goods inventories

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Inventory Management

Why do we have to manage inventories?

1. Under-stocking this is a serious problem as this can result in the following: a. Missed deliveries b. Lost sales c. Unsatisfied customers d. Production bottlenecks and worst, work stoppage 2. Overstocking- these are the possible effect of this: a. Holding cost might be too high b. Funds could have been used for a more productive venture thus improving operating performance

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Inventory Management

Two major concern of inventories

Timing of order Size of Order

1. 2.

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Types of Inventories (Contd)

Replacement parts, tools, & supplies Goods-in-transit to warehouses or customers

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Inventory Management

Functions of Inventory

To meet anticipated demand To smooth production requirements

To decouple operations
To protect against stock-outs

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Functions of Inventory (Contd)

To take advantage of order cycles To help hedge against price increases To permit operations To take advantage of quantity discounts

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Objective of Inventory Control

To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds/limits

Level of customer service

Costs of ordering and carrying inventory

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Effective Inventory Management

A system to keep track of inventory A reliable forecast of demand

Knowledge of lead times

Reasonable estimates of: Holding costs Ordering costs Shortage costs-Costs incurred when an item is out of stock; also called stockout costs. These costs include the lost contribution margin (cm) on sales plus lost customer goodwill. A classification system

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Key Inventory Terms

Lead time: time interval between ordering and receiving the order Holding (carrying) costs: cost to carry an item in inventory for a length of time, usually a year Ordering costs: costs of ordering and receiving inventory Shortage costs: costs when demand exceeds supply

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Inventory Counting Systems

Periodic System
Physical count of items made at periodic intervals

Perpetual Inventory System

System that keeps track of removals from inventory continuously, thus monitoring current levels of each item

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Inventory Counting Systems (Contd)

Two-Bin System - Two containers of inventory; reorder when the first is empty Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached
0

214800 232087768

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ABC Classification System

Figure 11.1

Classifying inventory according to some measure of importance and allocating control efforts accordingly.

A - very important B - mod. important C - least important

High Annual $ value of items Low

A B C
Few

Many

Number of Items

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ABS Classification - Guidelines

A B C

Percentage of total number of items Percentage of total annual value ($) Inventory control Purchasing process

10 to 20 % 30 to 40 % 40 to 50 % 70 to 80 % 15 to 20 %
Rigourous Precise with constant revisions Normal Normal

5 to 10 %
Simple Periodical

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ABC Analysis

Item Stock Number #10286

Percent of Number of Items Stocked 20%

Annual Volume (units) 1,000

Unit Cost $ 90.00

Annual Dollar Volume $ 90,000

Percent of Annual Dollar Volume 38.8%

Class A

#11526

500

154.00

77,000

33.2%

#12760

1,550

17.00

26,350

11.3%

#10867

30%

350

42.86

15,001

6.4%

#10500

1,000

12.50

12,500

5.4%

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ABC Analysis
Percent of Annual Dollar Volume 3.7% .5% .4% .2% .1% 100.0%

Item Stock Number #12572 #14075 #01036 #01307 #10572

Percent of Number of Items Stocked

Annual Volume (units) 600 2,000

Unit Cost $ 14.17 .60 8.50 .42 .60

Annual Dollar Volume $ 8,502 1,200 850 504 150 $232,057

Class C C C C C

50%

100 1,200 250 8,550

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Cycle Counting

A physical count of items in inventory

Cycle counting management

How much accuracy is needed? When should cycle counting be performed? Who should do it?

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Cycle Counting Example

5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C items Policy is to count A items every month (20 working days), B items every quarter (60 days), and C items every six months (120 days)

Item Class A B C

Quantity 500 1,750 2,750

Cycle Counting Policy Each month Each quarter Every 6 months

Number of Items Counted per Day 500/20 = 25/day 1,750/60 = 29/day 2,750/120 = 23/day 77/day

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Economic Order Quantity Models

EOQ models identify the optimal order quantity by minimizing the sum of annual cost.

Economic order quantity model

Economic production model

Quantity discount model

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Assumptions of EOQ Model

Only one product is involved Annual demand requirements known Demand is even throughout the year Lead time does not vary Each order is received in a single delivery There are no quantity discounts

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Total Cost

TC= Total annual cost Q= Order quantity in units H= Holding cost per unit D= Annual Demand S= Ordering cost

Annual Annual Total cost = carrying + ordering cost cost TC = Q H 2

DS Q

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Deriving the EOQ

Using calculus, we take the derivative of the total cost function and set the derivative (slope) equal to zero and solve for Q. The total cost curve reaches its minimum where the carrying and ordering costs are equal.
Q OPT = 2DS = H 2(Annual Demand)(Or der or Setup Cost) Annual Holding Cost

D S Q Length of order cycle Q / D Annual ordering cost No. of orders per year D / Q

QOPT= Q= H= D= S=

Optimum order quantity Order quantity in units Holding cost per unit Annual Demand Ordering cost

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EOQ MODEL EXAMPLE

A local distributor for a national tire company expects to sell approximately 9600 steel-belted radial tires of a certain size and tread design next year. Annual carrying cost is $16 per tire, and ordering cost is $75. The distributor operates 288 days a year. D= $ 9600 H= $ 16 S= $ 75 a) What is the EOQ? Q OPT = 2DS 2(9600)75 300 tires
H 16

b) No. Of orders per year=D/Q=9600/300=32

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EOQ MODEL EXAMPLE

D= $ 9600 H= $ 16 S= $ 75 c) Length of order cycle= Q/D= 300/9600 =1/32 of a year*288 =9 work days. d) Total Cost=Carrying cost+Ordering cost =(Q/2)H+(D/Q)S =(300/2)16+(9600/300)75 =2400+2400 =$ 4800

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Quantity Discounts

Quantity Discounts are price reductions for large orders offered to customers to induce them to buy in large quantities.

Annual Annual Purchasing + TC = carrying + ordering cost cost cost Q H TC = 2 + DS Q + PD

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Quantity Discount Example

Price $20 18 17

Range 1 to 49 50 to 79 80 to 99

D = 816 cases; S = $12; H = $4per case per year EOQ = sqrt(2DS/H) = sqrt(2*816*12)/4) = 69.97 or 70

100 or more

16

TC70= Carrying Cost + Order Cost + Purchase Cost = (70/2)*4 + (816/70)/12 + 18(816) = $14,968 TC80= Carrying Cost + Order Cost + Purchase Cost = (80/2)*4 + (816/80)/12 + 17(816) = $14,154 TC100= Carrying Cost + Order Cost + Purchase Cost = (100/2)*4 + (816/100)/12 + 16(816) = $13,354

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When to Reorder with EOQ Ordering

Reorder Point - When the quantity on hand of an item drops to this amount, the item is reordered

Safety Stock - Stock that is held in excess of expected demand due to variable demand rate and/or lead time. Service Level - Probability that demand will not exceed supply during lead time.

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Fixed-Order-Interval Model

Orders are placed at fixed time intervals Order quantity for next interval? Suppliers might encourage fixed intervals May require only periodic checks of inventory levels Risk of stockout

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Fixed-Interval Benefits

Tight control of inventory items Items from same supplier may yield savings in:

Ordering Packing Shipping costs

May be practical when inventories cannot be closely monitored

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Fixed-Interval Example
No jackets are in stock Target value = 50

3 jackets are back ordered It is time to place an order

Order amount (Q) = Target (T) - On-hand inventory - Earlier orders not yet received + Back orders Q = 50 - 0 - 0 + 3 = 53 jackets

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Single Period Model

Single period model: model for ordering of perishables and other items with limited useful lives Shortage cost: generally the unrealized profits per unit (Revenue per unit Cost per unit) Excess cost: difference between purchase cost and salvage value of items left over at the end of a period (Orig cost per unit Salvage per unit)

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Single Period Model

Continuous stocking levels

Identifies optimal stocking levels Optimal stocking level balances unit shortage and excess cost

Discrete stocking levels

Service levels are discrete rather than continuous

Desired service level is equaled or exceeded

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Continuous Stocking Example

Sweet cider is delivered weekly to Cindys Cider Bar. Demand varied between 30 500 liters per week. Cindy pays 20cents per liter for the cider and changes 80 cents per liter for it. Find the stocking level and its stockout risk fro that quantity. Ce= Cost per unit Salvage value = $.20 0 = $0.20 per unit Cs =Revenue per unit Cost per unit = $.80 .20 = $0.60 per unit

SL = Cs/(Cs +Ce) = .60/(.60 + .20) = .75

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Reorder Point

Inventory level at which a new order is placed

R = dL
where

d = demand rate per period L = lead time

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Reorder Point

Demand = 10,000 gallons/year Store open 311 days/year Daily demand = 10,000 / 311 = 32.154 gallons/day Lead time = L = 10 days R = dL = (32.154)(10) = 321.54 gallons

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END OF THE DISCUSSIONTHANK YOU SO MUCH