INVENTORY MANAGEMENT

Introduction Motives for holding Inventory Types of organization Holding Inventory Valuation of Inventory Goal of Inventory management Inventory Strategies and techniques Working Capital Restrictions Material Requirement Planning (MRP I)

Definitions
Inventory-A physical

resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be.

Inventory

Inventory

Def. - A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. Raw Materials Works-in-Process Finished Goods Maintenance, Repair and Operating (MRO)

Reasons for Inventories

Improve customer service Economies of purchasing Economies of production Transportation savings Hedge against future Unplanned shocks (labor strikes, natural disasters, surges in demand, etc.) To maintain independence of supply chain

Motives or purposes for holding inventory

1.

Transaction motive Precautionary motive Speculative motive

2.

3.

Cost and benefits

Costs : Ordering cost : fixed cost of placing and receiving an inventory order. It includes: 1. Preparing an purchase order. 2. Receiving, inspecting and recording to ensure both quantity and quality.

Ordering cost
It is generally fixed per order placed, irrespective of the amount of the order. The larger the orders placed, or the more frequent the acquisition made, the higher will be such costs. The larger the inventory , the fewer are the acquisition & the smaller or lower will be the cost. [inverse relation with the size of inventory]

Minimized the order cost

Such cost can be minimized by placing fewer order for a larger amount. But acquisition of a large quantity would increase the cost associated with the maintenance of inventory.

Carrying cost
The variable cost per unit of holding an item in inventory for a specified time period. It includes : 1. Cost of storing: Storage cost Insurance of inventory (fire & theft) Deterioration (technical obsolescence , price decline) Servicing cost (labour for handing inventory, clerical )

2. Opportunity cost of funds: expenses in raising funds (interest on capital ) to finance acquisition of inventory. If funds are not locked up in inventory, then they will yield a return. Carrying cost is directly related with the size of inventory. Total cost = ordering cost + carrying cost

Benefits of holding inventory

The basic function is to act as a buffer to decouple or uncouple the various activities: purchasing, production and selling. (uncoupling means that these interrelated activities of a firm can be carried on independently)

 Benefits

in purchasing Benefits in production Benefits in work-in-process Benefits in sales

Inventory Costs

Procurement costs: cost of replenishing inventory Carrying costs: cost of holding an item in inventory Out-of-stock costs: temporary or permanent loss of sales when demand cannot be met

Two Forms of Demand

Dependent
Demand for items used to produce final products Tires stored at a MRF plant are an example of a dependent demand item Demand for items used by external customers Cars, appliances, computers, and houses are examples of independent demand inventory

Independent

Inventory Control Systems

Continuous system (fixedorder-quantity)
constant amount ordered when inventory declines to predetermined level

Periodic system (fixed-timeperiod)

order placed for variable amount after fixed passage of time

GOAL OF INVENTORY MANAGEMENT

The goal of effective inventory management that is, to meet or exceed customers' expectations of product availability while maximizing the organization's net profits or minimizing its inventory related costs.

1. 2. 3. 4. 5.

Main emphasis on the following: Sales Forecasting or Demand Management Sales and Operations Planning Production Planning Material Requirements Planning Inventory Reduction

TECHNIQUES OF INVENTORY MANAGEMENT

ABC Classification
Class A
5 15 % of units 70 80 % of value

Class B
30 % of units 15 % of value

Class C
50 60 % of units 5 10 % of value

ABC Classification: Example

PART 1 2 3 4 5 6 7 8 9 10 UNIT COST $ 60 350 30 80 30 20 10 320 510 20 ANNUAL USAGE 90 40 130 60 100 180 170 50 60 120

ABC Classification: Example (cont.)

PART TOTAL PART VALUE % OF TOTAL % OF TOTAL UNIT COSTQUANTITY % CUMMULATIVE ANNUAL USAGE VALUE

9 8 2 1 4 3 6 5 10 7

$30,600 1 16,000 2 14,000 3 5,400 4 4,800 5 3,900 3,600 6 CLASS 3,000 7 2,400 A 8 1,700 B 9 C $85,400

10

35.9 6.0 $ 60 18.7 5.0 350 16.4 4.0 30 6.3 9.0 80 5.6 6.0 30 4.6 10.0 % OF TOTAL 4.2 18.0 20 VALUE ITEMS 3.5 13.0 10 12.0 9, 8,2.8 2 71.0 320 17.0 1, 4,2.0 3 16.5 510 6, 5, 10, 7 12.5

20

6.0 90 11.0 40 A 15.0 130 24.0 60 30.0 B 100 40.0 % OF TOTAL 58.0 180 QUANTITY 71.0 170 C 83.0 50 15.0 100.0 25.0 60 60.0 120

Example 10.1

Economic Order Quantity (EOQ) Models

EOQ
optimal order quantity that will minimize total inventory costs

Basic EOQ model Production quantity model The EOQ is that level of inventory which MINIMIZES the total of ordering and carrying costs

Assumptions of Basic EOQ Model

Demand is known with certainty and is constant over time (annual consumption) No shortages are allowed Lead time for the receipt of orders is constant Order quantity is received all at once

ORDERING COSTS Requisitioning Order Placing Transportation Receiving, Inspecting & Storing Clerical & Staff

CARRYING COSTS Warehousing Handling Clerical Staff Insurance Deterioration & Obsolescence

Inventory Order Cycle

Order quantity, Q

Reorder point, R

Inventory Level

Demand rate

Lead time Order Order placed receipt

Lead time Order Order placed receipt

Time

Balancing Carrying against Ordering Costs Annual Cost ($)

Minimum Total Annual Stocking Costs Total Annual Stocking Costs Annual Carrying Costs Annual Ordering Costs Smaller EOQ Larger Order Quantity

Lower

Higher

Economic Order Quantity

Where:
EOQ (Q) Co D Ch

EOQ =

economic order quantity Ordering Cost Annual Demand Cost of holding 1 unit

Economic Order Quantity cont.

Example:
The expected annual demand is 500,000. Purchase price is $100. It costs $ 500 to place an order and the cost of holding one unit in stock is 20%.

Economic Order Quantity cont.

$' 000s 300 250 200 150 100 50 ,0 0 ,0 0 ,0 0 ,0 0 0 0 0 ,0 0 0 ,0 ,0 ,0 ,0 1 2 3 4 5 6 7 8 9 0 ,0 00 0 0 0 0 0 0 0 0 0
Ch Co TC

EOQ
Q

STOCK LEVELS
1.

2. 3.

4. 5. 6.

MINIMUM LEVEL: Below which actual stock should not reduced. Must be maintained in hand all the time. MAXIMUM LEVEL: Level above which actual stock should not be exceed. RE-ORDERING LEVEL: Level of stock at which it is necessary to take steps for procurement of further lots of materials. DANGER LEVEL: Fixed below minimum level. LEAD TIME: (reorder point)- time taken in processing the order & then executing it. RATE OF CONSUMPTION: Average consumption of stock or material in the factory.

SELECTIVE CONTROL OF INVENTORY Different classification methods

Classification ABC [Always Better Control ] VED [ Vital, Essential, Desirable ]

Basis Value of items consumed The importance or criticality

FSN The pace at which the [ Fast-moving, Slow- material moves moving, Non-moving ] HML Unit price of materials [ High, Medium, Low ] SDE Procurement [ Scarce, Difficult, Easy Difficulties

INVENTORY TURNOVER RATIOS

It is the ratio by which it can be estimated that inventories have used efficiently. To ensure the blocking of only minimum funds in inventory. Also known as stock velocity. = COGS/ AVERAGE INVENTORY .

= NET SALES/ (AVEARGE) INVENTORY INVENTORY CONVERSION PERIOD: = DAYS IN A YEAR/ ITR

Just-in-Time JIT
Toyota was the first company to develop JIT Toyota needed to reduce costs of production and JIT was the solution. Companies thinking of introducing JIT will first have to: Find reliable suppliers Train employees to minimize wastages and idle time Improve quality Minimize lead times

VALUATION OF INVENTORIES
FIFO LIFO AVEARGE

METHOD: Simple average method weighted average method BASE STOCK METHOD STANDARD PRICE METHOD MARKET PRICE METHOD

Planning Supply Chain Activities

Anticipatory - allocate supply to each warehouse based on the forecast

Response-based - replenish inventory with order sizes based on specific needs of each warehouse

Material Requirements Planning (MRP) is a production planning and inventory control system used to manage manufacturing processes. Although it is not common nowadays, it is possible to conduct MRP by hand as well. An MRP system is intended to simultaneously meet three objectives: 1. Ensure materials and products are available for production and delivery to customers. 2. Maintain the lowest possible level of inventory. 3. Plan manufacturing activities, delivery schedules and purchasing activities.