INVENTORY MANAGEMENT

PRODUCTION AND OPERATION MANAGEMENT

PREPARED BY:

HSK

Overview

Introduction to inventory management Forms of inventories Inventory counting system Objectives Factors influencing inventory Classification of inventory costs Inventory management techniques ABC analysis EOQ (Basic EOQ model, Quantity Discounts and Reorder level) Key inventory terms

Inventory Management : Introduction

Marketing : Level of service Operations : stocks in sufficient quantities

Inventory Management Information Systems : Inventory control systems

Finance : Cash flow and Cost of money

Judicial Aspects : Ownership and responsibility

Inventory is material that the firm obtains in advance of need, holds until it is needed, and then used, consumes, incorporates into a product, sells, or otherwise disposes it of. A business inventory is temporary in nature. Inventories are stock of any kind like fuel and lubricants, spare parts and semi-processed materials to be stored for future use mainly in the process of production or it can be known as the ideal resource of any kind having some economic values.

Forms of inventories

There are many types of inventory. The form of inventories depends upon the type of concern. All types of inventory do not require same treatment and therefore policy with regard to each may also differ.

Raw material inventories:

There are raw materials and other supplies, parts and components, which enter into the product during the production process and generally form part of the product.

Work in process inventories:

These are semi finished, work in progress and partly finished products formed at the various stages of production.

m.r.o inventories/ Spare part inventories:

Maintenance, repairs and operating supplies which are consumed during the production process and generally do not form part of the product itself are referred to as spare part inventories.

Finished inventories:
These are complete finished products ready for sales. In a manufacturing unit, they are the final output of the production process. They can also be classified as: Movement inventories Lot size inventories Anticipation inventories Fluctuation inventories

Inventory Counting Systems

Periodic

System Inventory System

Physical count of items made at periodic intervals

Perpetual

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

 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

Objectives of Inventory Management

o o o o To Ensure smooth for flow of stock. of

To Provide Materials.

Required

Quality

To Control investment in Stock. Protection against fluctuating demand.

Protection against Fluctuations in Output. Minimization of Risk and Uncertainty. Risk of obsolescence. Minimization of Material Cost.

FACTORS AFFECTING INVENTORY

Type Type

of product of manufacture of production

Volume

FACTORS INFLUENCING INVENTORY

Manufacture

requires relatively long process

cycle-time. Procurement of materials has a long leadtime. Demand for finished products is sometimes seasonal and prone fluctuation. Material costs are affected by fluctuations in demand and subsequently by fluctuations in manufacturing.

Classification of inventory costs:

Inventories cost are traditionally categorized into four basic types:

PURCHASE COST:
For items that are purchased from outside the firms, this is usually the unit price that the firm pays to its vendor. As an item moves through the logistics system of the firms, it purchase cost in the inventory analysis should reflect its fully landed cost, by which is meant the cost to acquire and moves the item to that point in the system.

Ordering cost:
In addition to the per unit purchase cost, there is usually an additional cost which is incurred whenever we order, reorder or replenish the inventory. If we produce items internally then there will be an organization set up cost. This happens because we have to shut down the manufacturing line and change over, reconfigure the line to make a specific item. This is the cost involved with processing the order, involving paying the bill, auditing, and so forth.

Holding cost:
The cost that accrue due to the actual holding of the inventory over a time period. Many different kinds of cost can be considered as holding cost. The key characteristics of holding cost varies with the amount of inventory being held and the time that the inventory is held. The holding cost can further be classified as follows: Storage cost Service cost Risk cost Capital cost.

Shortage cost:
When a demand arises which cannot be satisfied from available inventory an inventory shortage occurs. Purchase, ordering and holding cost can be thought of as the cost of having inventories, while shortage cost result for not having inventory, or for not having enough inventory at the right place at the right time

INVENTORY CONTROL TECHNIQUES

Several Techniques of Inventory control are in use and it depends upon the convenience of the firm to adopt any of the technique.

Techniques of inventory Control are as follows:

Always better control (ABC) classification High, Medium and Low (HML) classification Vital, Essential and Desirable (VED) classification Scarce, Difficult and Easy to obtain (SDE) Fast moving, Slow moving and Non moving (FSN) Economic order quantity(EOQ) Max-Minimum System Two Bin System

The Techniques most commonly used are as follows:

Always

better control (ABC) classification Economic order Quantity (EOQ)

ABC Classification
One of the widely used techniques for control of inventories is the ABC Analysis. Objective of ABC control is to vary the expenses associated with maintaining appropriate control according to the potential savings associated with a proper level of such control.

ABC Analysis Classifies inventory according to some measure of importance and allocating control efforts accordingly.

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

ABC Classification : Guidelines

A Percentage of total number of items Percentage of total annual value (Rs.) Inventory control B C

10 to 20 % 30 to 40 % 40 to 50 % 70 to 80 % 15 to 20 %
Very Strict Control Moderate Control

5 to 10 %
Loose Control

Percentage of total annual usage value

100 90 Class A 80 70 60 50 40 30 20 10 0 10 20

Class B

Class C

30

40

50

60

70

80

90 100

Percentage of total number of inventory items

Procedure For Developing an ABC Analysis:

List each item carried in inventory by number or some other designation Determine the annual volume of usage and rupee value of each item Multiply each items annual volume of usage by its rupee value Compute each items percentage of total inventory in terms of annual usage in rupees

 Select

the top 70% of all items which have the highest rupee percentage and classify them as A items Select the next 20% of all items with the next highest rupee percentage and classify them as B items The next 10% of all items with the lowest rupee percentages are C items
Example on next slide is a typical illustration of the above procedure.

Example: From the following data draw an ABC Analysis graph after classifying A,B & C class items on the following basis:
Category A B C Item 1 2 3 4 5 6 7 8 Unit Price 200.0 2.0 5,000.0 12.5 9.0 25.0 1,000.0 70.0 Percentage of Total ACV 70 20 10 Annual Consumption (Units) 3000 60,000 20 200 350 6,000 40 300

Economic Order Quantity

Two questions:

How Much to order? When to order ?

 Buying

in large quantity will lead to the problem of high carrying cost in small quantity will lead to the problem of low carrying cost and high ordering cost

Buying

So, EOQ is a technique which solves the problem of the material manager.

Quantity) is the order size at which the total cost comprising ordering cost plus carrying cost, is the least.

Graphic Presentation Of EOQ

TOTAL COST
Costs Rs. TOTAL ANNUAL HOLDING COSTS TOTAL ANNUAL ORDER COSTS EOQ QUANTITY (UNITS)

 The

total cost curve reaches its minimum where the carrying and ordering costs are equal.

2DS 2(Annual Demand)(Order or Setup Cost) EOQ = = H Annual Holding or carrying Cost

Assumptions of the basic EOQ model

Demand is spread evenly throughout the year (constant demand rate) Lead time does not vary Price per unit of product is constant Inventory holding cost is based on average inventory Ordering costs are constant All demands for the product will be satisfied (no back orders are allowed)

 In

constructing any inventory model, the first step is to develop a functional relationship between the variables of interest and the measures of effectiveness. we are concerned with cost here, the following equation would pertain:

As

Total (Annual) Ordering Cost

Annual Ordering = Cost Number of Orders = Number of Orders X Cost per Order

Annual Demand Lot Size

D OC = xS Q

Annual Holding (Carrying) Cost

Holding cost = Average Inventory x Annual Holding Cost per Unit Average CYCLE inventory = Lot Size 2 Holding cost per unit = % Holding Cost X Unit Cost

Q HC = x H 2

Total Annual Cost

Q D TC = H + S +D C 2 Q
Annual Holding Cost Order or set-up cost Total acquisition cost

TC : Total annual cost D : Total annual demand Q : Quantity ordered H : holding cost S : Order or set-up cost

Example:
Omega is a company which manufactures megaphones. The company buys its speakers at a cost of Rs. 20 each. With each order, Omega must spend Rs. 50 (preparation of the purchase order, delivery, receiving, etc...). The annual demand for speakers is 10 000 units and the annual carrying cost is 20 % of the unit cost.

Quantity Discount Model

Quantity

discount

Price reduction offered to customers for placing large orders

Total Annual Cost

Q D TC = H + S +D C 2 Q
Annual Holding Cost Order or set-up cost Total acquisition cost

TC : Total annual cost D : Total annual demand Q : Quantity ordered H : holding cost S : Order or set-up cost C: Unit cost (price)

Steps in analyzing a quantity discount: 1. For each discount, calculate Q* 2. If Q* for a discount doesnt qualify, choose the smallest possible order size to get the discount 3. Compute the total cost for each Q* or adjusted value from Step 2 4. Select the Q* that gives the lowest total cost

Example:
Annual Demand = 5000 units Ordering cost per order = Rs. 49 Inventory Carrying Cost = 20% Cost per Unit = Rs. 5
Discount Number 1 2 3 Discount Quantity 0 to 999 1,000 to 1,999 2,000 and over Discount (%) no discount 4 5 Discount Price (P) Rs. 5.00 Rs. 4.80 Rs. 4.75

Reorder Point

EOQ The

answers the how much question

reorder point (ROP) tells when to order

Reorder point

Reorder point is that point of inventory at which an order should be placed for replenishing the current stock of inventory. Determinants of the reorder point The rate of demand The lead time The extent of demand and/or lead time variability

Reorder Point: Under Certainty

ROP = d LT where d = Demand rate (units per period, per day, per week) LT = Lead time (in same time units as d )

Demand rate

Annual Demand Working Days

Example:
Demand = 8,000 iPods per year 250 working day year Lead time for orders is 3 working days

d=

D Number of working days in a year

= 8,000/250 = 32 units ROP = d x L = 32 units per day x 3 days = 96 units

Reorder Point: Under Uncertainty

Demand or lead time uncertainty creates the possibility that demand will be greater than available supply To reduce the likelihood of a stockout, it becomes necessary to carry safety stock

Safety stock Stock that is held in excess of expected demand due to variable demand and/or lead time

Expected demand ROP = + Safety Stock during lead time

Example:
Annual Demand = 12000 units (360 days) Cost per unit = Rs. 1 Ordering Cost = Rs. 12 Per order Inventory carrying cost = 24% Normal lead time = 15 days Safety Stock = 1000 units Reorder level = ???

Key inventory terms

Minimum level or Safety Stock or Buffer Stock: level that need to be maintained for smooth production. Maximum Level: the level of stock beyond which a firm should not maintain the stock. Average stock level: calculated by dividing the minimum plus maximum level by 2. Lead Time: time interval between ordering and receiving the order.

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