Inventory ManagementInventory Management

• Inventory is a detailed list of those movable items which are necessary to manufacture a product and to maintain the equipment and machinery in god working order . The qty and value of every item is also mentioned in the list.

Characteristics of Characteristics of InventoryInventory

1. Inventory serves as cushions to absorb shocks.

2. Inventories are necessary evil:- As cost of not having inventories are usually greater than the costs of having them.

3. Mktg, prod’n, finance and purchasing decisions directly influence the level of inventory.

4. Inventory provides prod’n economies i.e. discounts on bulk purchase.

Importance of InventoryImportance of Inventory1. Provides and maintains good customer

service.2. Enables smooth flow of goods through the

prod’n process.3. Provides protection against the

uncertainties of demand and supply.4. Various prod’n operations can be performed

economically and independently.5. Ensures a reasonable utilization of

equipment and labour.6. With purchases in bulk discount can be

availed.

Inventory ClassificationInventory Classification1. TRANSIT INV.:- As under this there is a need

to transport inventories from one point to another larger the distance of supply source, larger is the transit inventory. Work in process transit inventories are determined by process design and plant layout.

2. BUFFER INV/Safety Stock.:-In any org. as a result of uncertainties of demand and supply some inventory is to be maintained.

3. DECOUPLING INV.:- The existence of inventories at major linkage points in a prod’n process makes it possible to carry an activities on either side of the point relatively independent of each other.

• Inventory can also be classified according to the nature of items stocked namely raw materials, in-process inventories, finished goods inventories and spare part inventories.

INVENTORY CTRLINVENTORY CTRL• Inv. Ctrl keeps track of inventories. It is

observed that ‘Too much', 'Too little’ or badly balanced inventories are all to be avoided because they cost too much on many counts

1. TOO MUCH leads to undue carrying charges in the form of taxes, insurance, storage, obsolescence and depreciation and undue proportion of total working capital is invested in them.

2. TOO LITTLE implies of too frequent ordering, loss of qty discounts and higher transportation charges.

THE BALANCE B/W TOO MUCH AND TOO LOW CAN BE DONE BY MEANS OF EFFECTIVE INV. CTRL.

• Inventory ctrl is the technique of maintaining the size of inventory at some desired level keeping in view the best economic interests of an organization.

Inventory ctrl means keeping a track of inventories, so that items are available when they are needed. This is achieved by:-

• Purchasing items at economic price at a proper time and in sufficient qty.

• Provision of suitable and secured storage location with sufficient space.

• Inventory identification system.• Up-to-date and accurate record keeping

by a responsible staff.• Appropriate requisition procedures

Objectives of Inventory Objectives of Inventory CtrlCtrl

1. Protection against fluctuations in demand:- If sufficient items are available in the inventory, then the fluctuations in demand can be easily adjusted and the org. can protect from unforeseen economic losses.

2. Better use of Men, Machine and Material:- The resources can remain engaged during slack period of demand and there will be no need of generating additional resources in the boom periods as then the inventory enlarged in slack period can be utilized. This will lead to uniform and proper utilization of resources available with the enterprise.

3. Protection against fluctuations in output:- It helps to reduce the gap b/w actual and scheduled production.

4. For production economies:- 5. Control of Stock volume:-Inv Ctrl is concerned

with the size and the value of goods present in stock. It is responsible to forecast the value of the stocks at regular intervals so that,

• Capital invested in inventories does not exceed the funds available for the purpose.

• The amt. invested in inventory is correctly recorded I a/c’s book.

• Protection against theft is ensured.

6. Ctrl of Stock Distributions6. Ctrl of Stock Distributions• Stock analysis is done to be sure

that it is in balance and that obsolescence and depreciation are kept at the minimum possible level.

• Inventory is maintained b’coz…………………………..?

1. To carry reserves in order to prevent stock outs or cost sales i.e. never to run out of any thing.

2. Never having much of anything on hand.

3. To gain economies in purchase by buying items beyond the desired amount.

4. To maintain reserves in stock for the period of replenishment.

Factors affecting Inv. Ctrl Factors affecting Inv. Ctrl PolicyPolicy

(A). Characteristics of the Manufacturing system:

The nature of the production process, the product design, prod’n planning and plant layout have significant affect on inventory policy. Some of these factors are:

1. Degree of specialisation and differentiation of the product at various stages:

The degree of changes in the nature of the product from raw material to final product at various stages of transformation determines the nature of inventory ctrl operation

2. Process Capability & 2. Process Capability & flexibilityflexibility

• Process capability is characterised by processing time of various operations e.g. the replenishment lead-time (length of delay in execution after issuance of replenishment order) directly influences the size of inventory.

• Inv. Policy should aim towards balancing the prod’n flexibility, capability, inventory levels and customer service needs

2. Process Capacity and storage 2. Process Capacity and storage facilityfacility

3. Quality requirements and obsolescence risks.

(B) (B) Amount of protection against Amount of protection against shortagesshortages

• There is always variation in demand and supply of the product. The protection against such unpredictable variations can be done by means of buffer stocks. The factors responsible for such variations are:

1. Change in size and frequency of orders.

2. Unpredictability of sales.

3. Physical and economic structure of distribution i.e. longer the channel of distribution the more is the inventory requirement.

4. Costs associated with failure to meet order/demand.

5. The accuracy, frequency and detail of demand forecasts

6. Protection against breakdown or other interruptions in prod’n.

(C.) Organizational (C.) Organizational factorsfactors

• There certain factors which are related to the policies, traditions and environment of any enterprise. Some of these are:-

1. Labour relation policies of the organisation.

2. Amount of capital available for stock.3. Rate of return on capital available if

invested elsewhere.

(D) Other factors(D) Other factors

• These are related to the overall business environment of the region :-

• Inflation• Strike situation in communication

facilities.• Wars or some other natural calamities

like famines, floods etc.• Difference b/w input and output.

Limitations of Inventory CtrlLimitations of Inventory Ctrl1. Efficient inventory ctrl methods can reduce

but cannot eliminate business risk.2. The objectives of better sales through

improved service to customer, reduction in inventories to reduce size of invt. And reducing cost of prod’n by smoother prod’n operations are conflicting with each other.

3. The ctrl of inventories is complex because of the many functions it performs. It should be viewed as a shared responsibility.

Costs in Inventory systemCosts in Inventory system

1. Purchase/Procurement cost:- Purchase cost in the inventory analysis shd. Reflect its fully landed cost, means cost to acquire and move the item to that point in the system. Thus landed cost include transportation costs, tariffs, taxes and any other cost incurred to make the item available at that point.

2. Ordering Costs:- If we produce the item internally, there may be an organization set-up cost. For an item, which is purchased from outside the firm, there is an administrative cost, which is incurred in the purchasing function.

3. Holding Cost:- 3. Holding Cost:- a) Storage costs:- Occur due to warehousing the

inventory . Storage cost are usually function of land and labour costs associated with running a warehouse, and thus can be expected to vary considerably from location to location.

b) Service costs:- are out of pocket expenses that arise in addition to the physical storage costs. Two typical examples are insurance and taxes.

c) Risk costs:- are intended to recognize that there can be considerable financial risk associated with holding an item in inventory, because the item may become lost, stolen, damaged etc.

d) Capital costs:- inventory ties up funds, which the firm could be using for other productive purposes.

e) Shortage costs:-When a demand arises which cannot be satisfied from available inventory an inventory shortage occurs.

Shortage Costs may exists as:-Shortage Costs may exists as:-• BACK ORDERS occur when the customer is willing

to wait for inventory to be made available. Costs accrue because the firm must maintain a system to record the backorder, maintain it and fill it when stock becomes available. The customer may eventually retaliate by reducing the number of orders, demanding compensation, or finding a new source.

• LOST SALES occur when the customer responds to an out-of-stock situation by canceling the demand.

• LOST CUSTOMER COSTS as it is very difficult to retain loyal customers.

• DISRUPTION COSTS occur in a production process when a shortage of raw material or component parts causes an interruption to the

A B C AnalysisA B C Analysis

• Always Better Control is an analytical techniques for classification of inventory items was first introduced by an AMERICAN FIRM- GENERAL ELECTRIC COMPANY.

• According to this analysis, there are three categories of inventory items A, B and C type . Depending upon their percentages of consumption.

• The significance of this analysis is that a very close ctrl is exercised over the items of ‘A’ group which account for high percentage of costs

• Less stringent ctrl is adequate for category ‘B’

• Very little ctrl would be sufficient for Category ‘C’.

Criteria A type B type C Type

Quantity 10% 20% 70%

Annual Usage 75% 15% 10%

Control Very strict

Moderate Less

Ordering Daily/weekly

Monthly Yearly

Safety stock Less Moderate High

Policies for ‘A’ group itemsPolicies for ‘A’ group items1. They should be ordered more frequently

to reduce capital lock up at a time in inventories as 15 percent of items cost 65 percent of total value.

2. The purchasing department shd. Make the maximum efforts to expedite and delivery of these items are to be stored as few in number as possible.

3. The purchase of these items shd. Be with top officials to ensure prompt services from the supplier.

4. The stock report of ‘A’ items shd. Be sent more frequently, say at least once in 15 days.

Policies for ‘B’ group itemsPolicies for ‘B’ group items• These account for 20 percent of total

quantity and 20percent of the total value.

• Order quantities, re-order stocks and safety stock shd. Be fixed and revised for ‘B’ items at least one in every 4 to 6 months.

• B items shd. Be ordered less frequently than A items

Policies for ‘C’ group itemsPolicies for ‘C’ group items

• C group of items account for 65 percent of quantity and hardly 15 percent of value.

• Large quantities can be brought at a time, as total investment will be least.

• Paper work can be reduced considerably if orders are placed once or twice a year.

• The source of supply can be one or two based on their reliability.

EXAMPLE OF ABC ANALYSIS

• Suppose three items P, Q, R have been used and their consumption is Rs. 2,40,000, Rs 24,000 and Rs. 2400 resp. Let us presume that ABC classification is not done and annual orders are 12 in number. Each item will be ordered 4 times and average inventory will be:

Item Annual consp(Rs.)

No. of Orders

Average Working Inventory

P 2,40,000 4 60,000

Q 24,000 4 6,000

R 2,400 4 600

Total 2,66,400 12 66,600

• Suppose A-B-C analysis followed and the number of orders will be according to the importance of the items. If the number of orders are 8, 3 and 1, for items P, Q and R resp, Then the average inventory will be as follows:

Item Annual Consp’n

No. of orders

Avg. working inventory

P 2,40,000 8 30,000

Q 24,000 3 8,000

R 2,400 1 2,400

Total 2,66,400 12 40,400

Advantages Of ABC AnalysisAdvantages Of ABC Analysis

1. It helps the material manager to exercise selective control and focus his attention only on a few items when he is confronted with lakhs of stores items.

2. Strict control over items involving good deals of investment.

3. Better alternative use of available working capital based on weightage of items.

4. Minimum of inventory costs-both procurement and carrying.

5. Reduced losses arising out of obsolescence.6. Sufficient safety of low value or C group of items.

LimitationLimitation• ABC analysis in order to be fully effective

shd. Be carried out with standardization and codification. ABC analysis is based on grading the items according to the importance of performance of an item that is by VITAL, ESSENTIAL and DESIRABLE (VED ANALYSIS) analysis. Some items, though negligible in monetary value may be vital for running the plant and constant attention is needed.

ConclusionConclusion

• When A-b-C analysis was not followed the average inventory was Rs. 66,600 and after following A-B-C analysis the average inventory came down to Rs. 40,400.

Economic Order Quantity Economic Order Quantity (EOQ)(EOQ)

• How much inventory should be bought in one lot under one order on each replenishment? Should the qty. to be purchased be large or small? Or, should the requirement of materials during a given period of time (say six or one year) be acquired in one lot or shd. It be acquired in installments or in several small lots?

SUCH INVENTORY PROBLEMS ARE

CALLED ORDER QTY PROBLEMS

Economic Order Quantity Economic Order Quantity (EOQ)(EOQ)

• EOQ is the size of the lot to be purchased which is economically viable. In determining EOQ it is assumed that cost of managing inventory is made up solely of two parts i.e. ordering costs and carrying costs.

Ordering CostsOrdering Costs• These are the costs which are associated

with the purchasing or ordering of materials.

• These costs are known as buying costs and will arise only when some purchases are made . These costs will include costs of setting up machinery for manufacturing materials, time taken up in setting , cost of tools. Etc.

• The ordering costs are totaled up for the year and then divided by the number of orders placed each year's.

Carrying CostsCarrying Costs• These are the costs for holding the

inventories. These costs will not be incurred if inventories are not carried.

• A firm shd. Place neither too large nor too small orders. On basis of trade-off between benefits derived from the availability of inventory and the cost of carrying that level of inventory, the appropriate or optimum level of the order to be placed shd. Be determined. The optimum level of inventory is popularly known as the ECONOMIC ORDER QTY also known as ECONOMIC LOT SIZE..

DEFINITIONDEFINITION• THAT level of inventory order that

minimizes the total cost associated with inventory management.

ASSUMPTIONSASSUMPTIONS• The firm knows with certainty the annual

usage (consumption) of a particular item of item.

• The rate at which the firm uses inventory is steady over time.

• The orders placed to replenish inventory stocks are received at exactly that point in time when inventories reach zero.

• Ordering and carrying costs are constant over the range of possible inventory levels.

The EOQ model can be illustrated by

1. The long analytical approach or trial and error approach

And2. The short cut or simple mathematical

approach

Trial and Error (Analytical) Trial and Error (Analytical) approachapproach

• Given the total requirements during given period of time depending upon the inventory planning horizon, a firm has different alternatives to purchase its inventories. For instance, it can buy its entire requirements in one single lot at the beginning of the inventory planning period. Alternatively, the inventories may be procured in small lots periodically.

• If the purchases are made in one lot, the average inventory holdings would be relatively large whereas it would be relatively small when the acquisition of inventory is in small lots, The smaller acquisition the lot, the lower is average inventory and vice versa

• ACC. To this approach the carrying and acquisition costs for different sizes of orders to purchase inventories are computed and the order size with the lowest total cost (ordering plus carrying ) of inventory is the economic order qty.

Mathematical (short cut Mathematical (short cut approach)approach)

• It can be calculated thru following equation:-

EOQ= √2 AB C

A= Annual Usage of inventory (units)B= Buying Cost per orderC= Carrying cost per unit.

LimitationsLimitations• The assumptions of a constant consumption/usage

and the instantaneous replenishment of inventories are of doubtful validity.

• Deliveries from suppliers may be slower than expected for reasons beyond control.

• It is possible that there may be an unusual and unexpected demand for stocks. To meet such contingencies, firms have to keep additional inventories which are known as safety stocks.

• There is a discrepancy b/w actual and the expected demand, leading to a wrong estimate to the EOQ as it says known annual demand for inventories.

Order Point Problem or Re-Order Point Problem or Re-order levelorder level

• REORDER point may be defined as the level of inventory when fresh order should be placed with the suppliers for procuring additional inventory equal to the EOQ.

AssumptionsAssumptions

• Constant daily usage of inventory• Fixed lead time

reorder point= Lead time in days * avg. daily usage of inventory

• The term LEAD TIME refers to the time normally taken in receiving the delivery after placing orders with the suppliers. The lead time may also be called as the procurement time of inventory.

• The avg. usage means the qty. of inventory consumed daily.

EXAMPLEEXAMPLE• The avg. consumption (daily usage) of

inventory of a firm is 5000 units. The number of days required to receive the delivery of inventory after placing order (lead i.e. processing and transit time) is 15 days. The re-order point=5000 units * 15 days=75000 units.

• The implication is that the firm shd place an order for replenishing the stock of inventory as soon as the level reaches 75,000 units.