Inventory Mgt Iiird Module.

8/6/2019 Inventory Mgt Iiird Module.

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INVENTORY MANAGEMENT

Introduction

Motives for holding InventoryTypes of organization Holding InventoryValuation of InventoryGoal of Inventory management

Inventory Strategies and techniquesWorking Capital RestrictionsMaterial Requirement Planning (MRP I)



Definitions

Inventory- A physical resource that a firmholds in stock with the intent of selling it or transforming it into a more valuable state.

Inventory System - A set of policies and

controls that monitors levels of inventory anddetermines what levels should bemaintained, when stock should bereplenished, and how large orders should be.



Inventory

Def. - A physical resource that a firm holds in stock withthe intent of selling it or transforming it into a morevaluable state.Raw MaterialsWorks-in-Process

Finished GoodsMaintenance, Repair and Operating (MRO)

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Reasons for Inventories

Improve customer service

Economies of purchasingEconomies of productionTransportation savingsHedge against future

Unplanned shocks (labor strikes, natural disasters,surges in demand, etc.)To maintain independence of supply chain



Motives or purposes for holdinginventory

1. Transaction motive

2. Precautionary motive

3. Speculative motive



Cost and benefits

Costs :

Ordering cost : fixed cost of placing andreceiving 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 frequentthe acquisition made, the higher will be such costs.The larger the inventory , the fewer are theacquisition & 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 wouldincrease the cost associated with themaintenance of inventory.



Carrying costThe variable cost per unit of holding an item ininventory for a specified time period.

It includes :1. Cost of storing:

Storage costInsurance of inventory (fire & theft)

Deterioration (technical obsolescence , pricedecline)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 willyield 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 onindependently)



Benefits in purchasing

Benefits in productionBenefits in work-in-processBenefits in sales



Inventory CostsProcurement costs: cost of replenishingcost of replenishinginventoryinventory

Carrying costs: cost of holding an item incost of holding an item ininventoryinventory

Out-of-stock costs: temporary or permanent losstemporary or permanent lossof sales when demand cannot be metof sales when demand cannot be met



Two Forms of Demand

DependentDependentDemand for items used to produceDemand for items used to producefinal productsfinal products

Tires stored at a MRF plant are anexample of a dependent demand item

IndependentIndependentDemand for items used by externalDemand for items used by external

customerscustomersCars, appliances, computers, andhouses are examples of independentdemand inventory



Inventory Control Systems

Continuous system (fixed-Continuous system (fixed-order-quantity)order-quantity)

constant amount orderedconstant amount orderedwhen inventory declines towhen inventory declines topredetermined levelpredetermined level

Periodic system (fixed-time-Periodic system (fixed-time-period)period)

order placed for variableorder placed for variableamount after fixed passage of amount after fixed passage of timetime



GOAL OF INVENTORYMANAGEMENT

• The goal of effective inventory management – that is, to meet or exceed customers' expectations of product availability whilemaximizing the organization's net profits or minimizing its

inventory related costs .

• Main emphasis on the following:1. Sales Forecasting or Demand Management2. Sales and Operations Planning

3. Production Planning4. Material Requirements Planning5. Inventory Reduction



TECHNIQUES OF INVENTORY TECHNIQUES OF INVENTORYMANAGEMENTMANAGEMENT



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

11 $ 60$ 60 909022 350350 4040

33 3030 13013044 8080 606055 3030 10010066 2020 180180

77 1010 17017088 320320 505099 510510 6060

1010 2020 120120

PARTPART UNIT COSTUNIT COST ANNUAL USAGEANNUAL USAGE



ABC Classification:Example (cont.)

Example 10.1Example 10.1

11 $ 60$ 60 909022 350350 404033 3030 13013044 8080 606055 3030 10010066 2020 180180

77 1010 17017088 320320 505099 510510 6060

1010 2020 120120

PARTPART UNIT COSTUNIT COST ANNUAL USAGEANNUAL USAGETOTAL % OF TOTAL % OF TOTALPART VALUE VALUE QUANTITY % CUMMULATIVE

9 $30,600 35.9 6.0 6.08 16,000 18.7 5.0 11.02 14,000 16.4 4.0 15.01 5,400 6.3 9.0 24.04 4,800 5.6 6.0 30.03 3,900 4.6 10.0 40.06 3,600 4.2 18.0 58.0

5 3,000 3.5 13.0 71.010 2,400 2.8 12.0 83.07 1,700 2.0 17.0 100.0

$85,400

A ABB

C C

% OF TOTAL % OF TOTALCLASS ITEMS VALUE QUANTITY

A 9, 8, 2 71.0 15.0B 1, 4, 3 16.5 25.0C 6, 5, 10, 7 12.5 60.0



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 whichThe EOQ is that level of inventory whichMINIMIZES the total of ordering and carryingMINIMIZES the total of ordering and carrying

costscosts



ORDERING COSTSORDERING COSTS CARRYING COSTSCARRYING COSTS

RequisitioningRequisitioning WarehousingWarehousing

Order PlacingOrder Placing HandlingHandling

TransportationTransportation Clerical Staff Clerical Staff

Receiving,Receiving,InspectingInspecting && StoringStoring

InsuranceInsurance

Clerical & Staff Clerical & Staff Deterioration &Deterioration &ObsolescenceObsolescence



Inventory Order Cycle

DemandDemandraterate

TimeTimeLeadLeadtimetime

LeadLeadtimetime

Order Order placedplaced

Order Order placedplaced

Order Order receiptreceipt

Order Order receiptreceipt

InventoryLevel

InventoryLevel

Reorder point,Reorder point, R R

Order quantity,Order quantity, Q Q

00



Balancing Carrying againstBalancing Carrying againstOrdering CostsOrdering Costs

Annual Cost ($)Annual Cost ($)

Order QuantityOrder Quantity

MinimumMinimumTotal AnnualTotal Annual

Stocking CostsStocking Costs

AnnualAnnualCarrying CostsCarrying Costs

AnnualAnnualOrdering CostsOrdering Costs

Total AnnualTotal AnnualStocking CostsStocking Costs

Smaller Smaller Larger Larger

L o w e r

L o w e r

H i g h e r

H i g h e r

EOQEOQ



Economic Order QuantityEconomic Order Quantity

EOQ = 2Where:EOQ (Q) economic order quantityCo Ordering CostD Annual DemandCh Cost of holding 1 unit



Economic Order QuantityEconomic Order Quantity cont.cont.

Example:Example: The expected annual demand is 500,000. The expected annual demand is 500,000.

Purchase price is $100. It costs $ 500 toPurchase price is $100. It costs $ 500 toplace an order and the cost of holding oneplace an order and the cost of holding oneunit in stock is 20%.unit in stock is 20%.



Economic Order QuantityEconomic Order Quantity cont.cont.

-

50

100

150

200

250

300

1 , 0

0 0

2 , 0 0

0

3 , 0 0

0

4 , 0 0

0

5 , 0 0

0

6 , 0 0

0

7 , 0 0

0

8 , 0 0

0

9 , 0 0

0

1 0 , 0

0 0 Q

$' 000s Ch

Co

TC

EOQ



STOCK LEVELSSTOCK LEVELS

1.1. MINIMUM LEVEL: Below which actual stock shouldMINIMUM LEVEL: Below which actual stock shouldnot reduced. Must be maintained in hand all thenot reduced. Must be maintained in hand all thetime.time.

2.2. MAXIMUM LEVEL: Level above which actual stockMAXIMUM LEVEL: Level above which actual stock

should not be exceed.should not be exceed.3.3. RE-ORDERING LEVEL: Level of stock at which it isRE-ORDERING LEVEL: Level of stock at which it isnecessary to take steps for procurement of furthernecessary to take steps for procurement of furtherlots of materials.lots of materials.

4.4. DANGER LEVEL: Fixed below minimum level.DANGER LEVEL: Fixed below minimum level.5.5. LEAD TIME: (reorder point)- time taken inLEAD TIME: (reorder point)- time taken in

processing the order & then executing it.processing the order & then executing it.6.6. RATE OF CONSUMPTION: Average consumption of RATE OF CONSUMPTION: Average consumption of

stock or material in the factory.stock or material in the factory.



SELECTIVE CONTROL OF INVENTORY SELECTIVE CONTROL OF INVENTORY Different classification methodsDifferent classification methods

ClassificationClassification BasisBasisABCABC

[Always Better[Always BetterControl ]Control ]

Value of itemsValue of itemsconsumedconsumed

VEDVED

[ Vital, Essential,[ Vital, Essential,Desirable ]Desirable ]

The importance orThe importance or

criticalitycriticality

FSNFSN[ Fast-moving, Slow-[ Fast-moving, Slow-

moving, Non-moving ]moving, Non-moving ]

The pace at which theThe pace at which thematerial movesmaterial moves

HMLHML[ High, Medium, Low ][ High, Medium, Low ]

Unit price of materialsUnit price of materials

SDESDE[ Scarce, Difficult, Easy[ Scarce, Difficult, Easy

ProcurementProcurementDifficultiesDifficulties



INVENTORY TURNOVERINVENTORY TURNOVERRATIOSRATIOS

It is the ratio by which it can be estimated thatIt is the ratio by which it can be estimated thatinventories have used efficiently.inventories have used efficiently.

To ensure the blocking of only minimum funds in To ensure the blocking of only minimum funds in

inventory.inventory.

Also known as stock velocity.Also known as stock velocity.= COGS/ AVERAGE INVENTORY.= COGS/ AVERAGE INVENTORY.

= NET SALES/ (AVEARGE) INVENTORY= NET SALES/ (AVEARGE) INVENTORY

INVENTORY CONVERSION PERIOD:INVENTORY CONVERSION PERIOD:= DAYS IN A YEAR/ ITR= DAYS IN A YEAR/ ITR



VALUATION OF INVENTORIESVALUATION OF INVENTORIES

FIFOFIFOLIFOLIFOAVEARGE METHOD:AVEARGE METHOD:

Simple average methodSimple average methodweighted average methodweighted average method

BASE STOCK METHODBASE STOCK METHOD

STANDARD PRICE METHODSTANDARD PRICE METHODMARKET PRICE METHODMARKET PRICE METHOD



Planning Supply Chain ActivitiesAnticipatory - allocate supply to each

warehouse based on the forecast

Response-based - replenish inventory

with order sizes based on specificneeds of each warehouse



• Material Requirements Planning (MRP) is a productionplanning and inventory control system used to managemanufacturing processes. Although it is not commonnowadays, it is possible to conduct MRP by hand as well.

• An MRP system is intended to simultaneously meet threeobjectives:

1. Ensure materials and products are available for productionand delivery to customers.

2. Maintain the lowest possible level of inventory.

3. Plan manufacturing activities, delivery schedules andpurchasing activities.



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Inventory Mgt Iiird Module.

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