Inventory Management

K.U.B.S
Inventory Costs
Inventory procurement, storage and management is associated
with huge costs associated with each these functions.

Inventory costs are basically classified into three main categories;

1. Ordering Cost (also called setup cost)

2. Carrying Cost (also called holding cost)

3. Shortage Cost (also called Stock out Cost and cost of replenishment )
Ordering Cost
 Item Cost:
 Transportation Cost
 Custom Duties
 Insurance

 Order Placing Cost:

 Purchase order cost
 All kinds of clerical cost
 Communication cost
 Others

Two basic fundamental questions;

1. How much to order? ----------- e.g. EOQ
2. When to order?---------------- e.g. MRP
Transportation Cost
The amount charged for the transportation is based on the rate a
carrier changes from point A to point B.

Terminologies:
 FTL - Full Truck Load (Full capacity utilized of the carrier)
 Transportation costs are a part of the ordering cost.

 LTL - Less Than Truck Load

 Transportation costs are a part of the unit cost.
 LTL rates are first based upon product class published by – NMFC
(National Motor Freight Classification)
Then the carrier’s tariff is used based on the origin and
destination -NMFTA (National Motor Freight Traffic Association).
Example
Given the following annual costs, calculate the average cost of placing
one order.
Annual staff salaries = Rs. 6,00,000
Annual Supplies and operating expenses = Rs. 25,000
Variable Cost (i.e. setting up work centers for an order) = Rs. 1000
Orders placed each year = 2000

Solution:
Average cost = Fixed costs + Variable cost
No. of orders

= Rs.6,00,000 + Rs.25,000 + Rs. 1000 = Rs. 1312.50

2000
Carrying Costs
Carrying costs Include all expenses of inventory carried.
Categories are;
• Capital Costs:
 includes every thing related to investment. e.g. taxes,
insurance cost, cost associated with legal liabilities..
• Storage Costs:
 Space
 Workers
 Equipments

• Risk Costs:
 Obsolescence – Lost of product value
 Damage – damaged while being held or moved
 Pilferage – goods lost, stolen
 Deterioration – waste, shelf life is limited
Example # 1
A Company carries an average annual inventory of Rs. 12,000,000. If
they estimate the cost of capital is 10%, storage costs are 7%, and
risk costs are 5%, what does it cost per year to carry this inventory.

Solution:
Total cost of carrying inventory = 10% + 7% + 5% = 22%
Annual cost of carrying inventory = 22 x 120,00,000
100
= Rs. 264,0000/-
Example # 2
A company makes and sells a seasonal product. Based on a sale following
forecast data. Calculate a level production plan, quarterly ending inventory,
and average quarterly inventory. If inventory holding cost is $4 per unit
per quarter, what is the annual cost of holding inventory? Opening and
ending inventories are zero.

Qtr 1 Qtr 2 Qtr 3 Qtr 4 Total

Forecast Demand 2000 3000 6000 5000 16,000
Production
Ending Inventory (0)
Average Inventory

Inventory Cost (in $)

Example Problem (Cont.)

Solution;
Qtr 1 Qtr 2 Qtr 3 Qtr 4 Total

Forecast Demand 2000 3000 6000 5000 16,000

Production 4000 4000 4000 4000 16,000

Ending Inventory (0) 2000 3000 1000 0

Average Inventory 1000 2500 2000 500

Inventory Carrying
Cost (in dollars, @ 4000 10000 8000 2000 24,000
$4/unit/qtr)
Stock Out Costs
If demand exceeds forecast during lead time.

A stock out can potentially be expensive because;

 Back order cost i.e. negative customer relations
 Possible lost customer
 Lost sales

 If the carrying cost of inventory is less than backorder costs (this is

true in most cases), the company should over-produce and keep an
inventory called safety inventory.
Master Production Schedule (MPS)
 MPS is a plan for the production of individual end items.

 It breaks down the production plan to show, for each period, the
quantity of each end item to be made.

 It forms the link between production planning and actual production.

 It form the basis for calculate the capacity and resources needed.

 The MPS drives the material requirement plan.

 The primary priority plan for manufacturing.

 The level of detail is higher than the production plan.

Inputs to Develop MPS

Forecast for individual end items.

Actual orders from customers.

The production plan data.

Inventory level for individual end items.

Existing Capacity .
Objectives and Steps for the MPS
Objectives:
 Maintain good customer service.
 Make effective use of resources.
 Maintain effective levels of inventory.

Steps:
 Develop a preliminary MPS.

 Check preliminary MPS against capacity and resources.

 Resolve differences between the preliminary MPS and capacity
availability.
Comparison Between Capacity and
Demand Forecast
 If (MPS) capacity required < capacity available, then MPS is OK

 If (MPS) capacity required > capacity available, then capacity

increase must be investigated

 Ways of increasing capacity:

1. Extra worker/ additional shift / Over time

2. Re-route
Or
Sub-contracting

 If capacity increase is not possible, then MPS must be revised .

MPS Relationship to Production Plan
 Product wise opening inventories (units) are;
Product A = 350 units
Product B = 100 units
Product C = 50 units
500 units

Developed production plan for 3 products;

Week 1 2 3 4 5 6

Aggregate Forecast (Units) 160 160 160 160 215 250

Production Plan 205 205 205 205 205 205

MPS Relationship to Production Plan (Cont.)

Forecast demand product wise breakup;

Week 1 2 3 4 5 6 Total

Product A 70 70 70 70 70 80 430

Product B 40 40 40 40 95 120 375

Product C 50 50 50 50 50 50 300

Total 160 160 160 160 215 250 1,105

MPS Relationship to Production Plan (Cont.)
Master Scheduling;
Product Week 1 2 3 4 5 6
Forecast 70 70 70 70 70 80
A Production 205
Inventory(350) 280 210 140 70 0 125
Forecast 40 40 40 40 95 120
B Production 205 205 205
Inventory (100) 60 20 185 350 460 340
Forecast 50 50 50 50 50 50
C Production 205 205
Inventory (50) 205 360 310 260 210 160
Production 205 205 205 205 205 205
Overall
Inventory 545 590 635 680 670 625
Material Requirements Planning
 (MPS) concern with the end items, or major components.

 These items are made or assembled from components that

must be available in the right quantities and at the right
time to meet the MPS requirements.

 If any component is missing, the product cannot be built

and shipped on time.

 Material requirements planning (MRP) is the system used

to avoid missing parts.
Types of Demands
There are two types of demands;

1. Independent Demand
 It must be forecast
 It is not related to the demand for any other assemblies or products.

2. Dependent Demand
 Directly related to the demand for higher-level assemblies or
products.
 It can be calculated.

 MRP is designed to do dependent demand calculation.

Major Objectives of MRP
1. Ensure the availability of material, components and
products for planned production and for customer
delivery.

2. Maintain the lowest possible inventory.

3. Plan delivery schedules and purchasing activities as

per established schedule .
Major Inputs to MRP
1. Master Production Schedule:
 Statement of end items to be produced.
 The quantities of each end items.
 Dates they are to be completed.

2. Inventory Records:
 Planning factors i.e. order quantities, lead times, and safety stock.
 Current status of each item

3. Bills of Material:
 It shows required quantities of all parts to make one of the
product.
 Each part or item has only one part number.
 A part is defined by its form, fit , or function.