Inventory Management & Selective Control/ABC Analysis

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In this u will see the function of inventory, factors influencing management and control, benefits, process, and selective inventory control.

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Inventory Management & Selective Control/ABC Analysis

  1. 1. 1 CHETANA’S BACHELOR OF MANAGEMENT STUDIES SUBJECT: Production Management and Material Management TOPIC: Inventory Management & Selective Control/ABC Analysis Sr.No Name Roll no 1. PANKAJ GHARANYA 2117 2. ABBAS SAYED 2153 3. MUSTAQEEM NAVRANGE 2141 4. MUKESH DYNMA 2111 5. MANOJ ABRAHAM 2139 6. AZAR HASHMI 2122 Under The Guidance Of: Prof. VijuNavare Group no. 8
  2. 2. 2 MEANING AND DEFINITION The term inventory has been defined by several authors. The more popular of them are “the term inventory includes material-raw, in process, finished packaging, spare and other stock in order to meet an unexpected demand or distribution in future”. Yet another definition is that the term inventory includes the following categories of items: 1. Production inventories: Raw materials, parts, and components which enter the firm‟s items manufactured to company specification, and standard industrial items purchased „off the shelf‟ 2. MRO inventories: Maintenance, repairs and operating supplies which are consumed in the production process but which do not become part of the product. (e.g., lubricating oil, soap, machine repairs parts) 3. In-process inventories: Semi-finished products found at various stages in the production operation. 4. Finished goods inventories: Completed products ready for shipments. FUNCTIONS OF INVENTORY One reason organizations maintain inventory is that it is rarely possible to predict sales levels, demand and usage patterns exactly. In such situations, inventory serves as a buffer against uncertain and fluctuating demand and keeps a supply of items available in case items are needed by the organization or its customers. The many functions that inventories perform can be summarized as follows: a) Smoothing out irregularities in supply: Inventories provide a buffer to overcome the problems of uncertainties I supplies such as delayed deliveries and supply of short quantities by vendors as against the promised delivery schedules and quantities. Also, the customer demand for the goods may increase suddenly which affects the ability of the manufacturer to meet the customer demand. In such cases also, an inventory of finished goods held in the warehouses will act as a buffer against the uncertainties in demand. Thus, inventories fill the gap between supply and demand. b) Buying or producing in lots or batches: When the demand for an item does not justify its continued production throughout the year, it is produced in batches or lots on an intermittent basis. During the time when the item is not being produced, demands are met from the inventory which is accumulated by batch production.
  3. 3. 3 c) To meet seasonal or cyclical demand: Companies will produce items at a constant production rate more than the demand rate in order to meet the seasonal demand occurring at a later period for which the production capacity is insufficient. d) To take advantage of price discounts while buying items: A company will often purchases large amounts of inventory to take advantage of price discounts, as a hedge against anticipated price increases in the future. e) To maintain continuity to operations in production process: Many companies find it necessary to maintain in-process inventories at different stages in a manufacturing process to provide independence between operations and to avoid work stoppages or delays and to continue production smoothly if there are temporary machine breakdowns or other work stoppages. INVENTORY MANAGEMENT AND CONTROL Because of high cost involved in inventories, their proper management and control assume considerable importance. In fact, the management of inventory isgiven such an importance, that, it is often treated synonymous with materials management. Inventory management involves the„development and administration of policies, systems, and customer service requirement, productions scheduling, purchasing and traffic‟. Inventory control, on the other hand, is defined in a narrower sense then inventories management pertains primarily to the administration of establish policies, system and procedures. For e.g., the actual steps taken to maintain the stock levels or stock records refers to inventory control. FACTORS INFLUENCING INVENTORY MANAGEMENT AND CONTROL Several factors influence inventory management and control. The principle effects of this factor are reflected most strongly on the levels of inventories and the degree of control, planned in the inventory control system. The factors include type of product, type of manufacture, volume of output and others. Type of Product Among the factors influencing inventory management and control, the type of product is fundamental. If the material used in the manufacture of the product has a high unit value when purchased, a much closer control is usually in order. Jewelers are much more careful of their stocks of diamonds then are with display cases full of low- priced costume jewelry this same principle hold manufacturing also.
  4. 4. 4 If the material used in the product is in short supply or is rationed by the government, this may influence the purchase of this material and it stock maintained. Type of Manufacture Beside type of product, types of manufacture also influence inventory management and control. Where continuous manufacture is employed the rate of production is the key factor. Here inventory control is of major importance and in reality controls the production of the product. The economic advantage of this type of manufacture is the uninterrupted operation of the machines and assembly lines in the plant. It is a major offence on the part of the inventory personnel to have the plant shut down for the lack of material. Volume of Production The volume of product to be made as represented by the rate of production may have little effect on the complexity of the inventory problem. Literally, millions of brass bases for lights bulbs manufactured each month involving the control of only two principle item of raw material inventory. On the other hand manufacturer of a large locomotive involves the planning and control of thousands of items of inventory. Both the inventory problems and the difficulty of controlling production increase in difficulty of controlling production increase in difficulty with the number of components parts of the product and not with quantity of products to be made. BENEFITS OF INVENTORY MANAGEMENT CONTROL Proper management and control of inventories will result in the following benefits to an organization. 1. Inventory control ensures an adequate supply of materials, stores, etc., minimizes stock outs and shortages,and avoids costly interruptions in operations. 2. It keeps down investment in inventories, inventory carrying costs and obsolescence loses to the minimum. 3. If facilitates purchasing economies through the measurement of requirements on the basis of recorded experience. 4. It eliminates duplication in ordering or in replenishing stocks by centralizing the source from which purchase requisitions emanate. 5. It permits a better utilization of available stocks by facilitating inter-department transfers within a company. 6. It provides a check against the loss of materials through carelessness or pilferage.
  5. 5. 5 7. It facilitates cost accounting activities by providing a means for allocating material costs to products, departments or other operating accounts. 8. It enables management to make cost and consumption comparisons between operations and periods. 9. It serves as a means for the location and disposition of inactive and obsolete items of stores. 10. Perpetual inventory values provide a consistent and reliable basis for preparing rapt restatements. PROCESS OF INVENTORY MANAGEMENT AND CONTROL As mentioned earlier, inventory management and control refers to the planning for optimum quantities of materials at all stages in the production cycle and evolving techniques which would ensure the availability of planned inventories. Four steps are involved in the process, viz. Step 1.Determination of optimum inventory levels and procedures of their review and adjustment. Step 2 Determination of the degree of control that is required for the best results. Step 3 Planning and design of the inventory control system. Step 4 Planning of the inventory control organization. Step1. Determination of Optimum Inventory Levels Determination of inventory that an organization should hold isa significant but difficult step. Too much of inventory results in locking up of working capital a company by increased cost (but reduce ordering cost). Excess inventories, however, guarantee uninterrupted supply of materials and components, to meet production schedule and finished goods to meet customers demand. Too less of inventory releases working capital for alternative uses and reduces carrying cost and increase ordering cost. But there is a risk of stock out of costs A few suggestions may be offered which might help to overcome this problem. The trend of sales must be watched closely and inventories adjusted in advance of the change in rate of production as determined by actual sales. Hence, inventory management must plan for the review of the stock often.
  6. 6. 6 Step2. Determination of Degree of Control The second aspect of inventory management is too decided just how much control is needed to realize the objectives of inventory management. The difficulties are best overcome by classification of inventory on the basis of value. Popularly called the ABC classification, this approach is useful in deciding the degree of control. „A‟ class items are „high‟ in value but „low‟ in quantity, „C‟ class inventories are the opposite of „A‟ group, i.e., „high‟ in quantity and „low‟ in value. In between are the „B‟ groups stocks which are more or less equal in quantity and value proportion to the total inventory. Tight control is exercise on „A‟ category items through accurate records of receipts and issues and by coordination of incoming shipments with production requirements. On the other hand, „C ‟class items may simply ordered in large quantities covering several months need, no record being made of their issue to manufacturing. More stock is simply requested when the existing stock reaches a reorder point. The „B‟ class items received not so tight control, but are not neglected either. Step3. Planning and Design of the Inventory System An inventory system provides the organizational restructure and the operating policies for maintaining and controlling goods to be inventoried. The system is responsible for ordering and receipts of goods, timing the order placement and keeping track of what has been ordered, how much, and from whom. Further, the system must provide follow up to enable the answering such question as: Has the vendor received the order? Has it been shipped? Are the items correct? Is the procedure established for reordering or returning undesirable merchandise? SELECTIVE INVENTORY CONTROL Because of the large number of materials used in production at many manufacturing plants, it is desirable to classify materials according to the amount of analysis that can be justified. Selective inventory control means that the method of inventory control varies from item to item and the differentiation should be on selective basis. Several techniques of inventory control are in use and it depends on the convenience of the firm to adopt any of the techniques. The techniques more commonly used are the following: Always better control (ABC) classification High, medium and low (HML) classification Vital, essential and desirable (VED) classification Fast moving, slow moving and non-moving (FSN)
  7. 7. 7 Mix- minimum system Two bin system ABC ANALYSIS – One of the widely used techniques for control of inventories is the ABC (Always better control) analysis. The objective of ABC control is to vary the expenses associated with maintaining appropriate control according to the potential savings associated with proper level of such control. For example, an item having an inventory cost of Rs. 1000000 such as sheet steel, has a much greater potential for savings expenses related to maintaining inventories than an item with a cost of Rs.100 the ABC approach is a means of categorizing inventory items into three classes „A‟, „B‟ and „C‟ according to the potential amount to be controlled. Once inventory is classified, we have a firm base for deciding where we will put our effort. Logically, we expect to maintain strong controls over the „A‟ items talking whatever special actions needed to maintain availability of these items and hold stocks at the lowest possible level consistent with meeting demands. At the other end of the scale, we cannot afford the expense of rigid controls, frequent ordering, expediting, etc. because of the low amounts in this area. Thus, with the „C‟ group we may maintain somewhat higher safety stocks, order more months of supply; expect lower levels of customer service, or all the three. It is for this selective approach, ABC analysis is often called the selective Inventory Control Method (SIM). Extending pareto‟s principle to inventory, it is always possible and necessary to separate “vital few” from “trivial many” of the stock items for their effective control. Separating vital few from trivial many is what is precisely done in ABC analysis. Pareto‟s principle was brought to the attention of people concerned with inventory management by H. Ford Dickie, who applied pareto‟s law inventory and developed the general concept of ABC analysis. Like so many ideas, however it has not been completely understood. Many people refer to the ABC system or the ABC technique. The idea of distribution of value for inventory stratification is neither a system nor a technique; it is a fundamental management principle with universal application potential. Advantage of ABC Analysis This approach helps the materials manager to exercise selective control and focus attention on „A‟ category items. By controlling the inventory of „A‟ category items, the total inventory costs can be considerably reduced. Usually, fixed order quantity system or „Q‟ system of inventory control is used for „A‟ category items advising the supplier to follow staggered supplies (i.e. EOQ is ordered and the supplier is asked to supply fraction of EOQ on weekly basis to match the consumption rate). For „B‟ category items the fixed order cycle system on „P‟ system is used without appreciably increasing the average inventory value. For „C‟ category
  8. 8. 8 items “two-bin system” is used wherein the annual requirement of the item is ordered in one or two lots and the quantity received is distributed into two bins-bin number one keeping the re- order level inventory and bin number two keeping he balance quantity. The item is consumed from bin number two and once it becomes empty, the repeat order is placed for the annual or six month‟s requirement. Item is issued from the first bin till the supply is received. Limitations of ABC Analysis i. To be fully effective, it should be carried out with standardization and codification. ii. Importance is given to an item based only on its annual consumption in value and not on its criticality for the production. iii. It should be reviewed periodically so that changes in prices and consumption are taken into account. iv. It does not apply to dependent demand inventory which is controlled by Material Requirement Planning (MRP) system. MINIMUM-MAXIMUM TECHNIQUE The minimum-maximum system is often used in connection with manual inventory control system. The minimum quantity is established in the same way as any re-order point. The maximum is the minimum quantity plus the optimum lot size. In practice, a requisition is initiated when a withdrawal reduces the inventory below the minimum level, the order quantity is the maximum minus the inventory status after the withdrawn reduce the stock level substantially below the minimum level, the order quantity will be longer than the calculated EOQ. The effectiveness of a minimum-maximum system is determined by the method and precision with which the minimum and maximum parameters are established. If these parameters are based upon arbitrary judgments with the limited factual basis, the system will be limited in its effectiveness. If the minimum are based on an objective rational basis, the system can be very effective. TWO-BIN TECHNIQUE Once of the oldest system of inventory control is the two-bin system which is mainly adopted to control „C‟ group inventories. In the two-bin system, stock of each item is separated into two-bins. One bin contains stock, just enough to last from the date a new order is placed until it is received in inventory. The other bin contains a quantity of stock enough to satisfy probable demand during the period of replenishment is placed, and the stock in the second bin is utilized until the ordered material is received.
  9. 9. 9 Such a method is appropriate to ideal conditions in which rate of consumption is fairly constant and for items lead time of which is fairly established and regular. Although the system itself possesses a high degree of automacy, in practice, we need to allow for variations in the rate of consumption as well as lead time. A possible disadvantage of the system in some case is the requirement of additional storage facilities and perhaps some practical difficulty in keeping the two stocks properly separated. V-E-D ANALYSIS „V‟ stands for vital, „E‟ for essential and „D‟ for desirable. This classification is usually applied for spare parts to be stocked for maintenance of machines and equipments based on the criticality of the spare parts. The vital spare parts are those which can cause stoppage of the plant if not available. Usually such spare parts are known as capital or insurance spares. The inventory policy is to keep at least one number of the vital spare irrespective of its value. Also, spare parts to be supplied by foreign manufactures are treated as vital spares because of the long lead time required for procurement. Essential spare parts are those whose non-availability may not adversely affect production. Such spare parts may be available from many sources within the country and the procurement lead time may not be long. The desirable spare parts are those which if not available can be manufactured by the maintenance department or may be procured from local suppliers and hence no stock is held usually. F-S-N ANALYSIS It stands for Fast-moving, Slow-moving and Non-moving items. It is based on past consumption pattern. Items which are usually drawn from stores frequently are classified as fast moving items; Items which are drawn only once or twice a year are classified as slow moving items not at all drawn for the past two years are classified as non-moving items. F-S-N analysis is useful to control obsolescence of raw materials, components, tools and spare parts. H-M-L ANALYSIS This stands for High value, medium value and low value items on unit price of the item. For instance, a firm may decide to categories items having unit price of the item. For instance, firm may decide to categories items having unit price more than Rs. 5000 as „H‟ items. From Rs. 1000 to 5000 as „M‟ items and below Rs. 1000 as „L‟ items. On the basis, materials management may delegate authority to various levels of purchase officers/mangers to authorize and sign purchase orders. Also, for high value items, alternative source of supplier are developed.
  10. 10. 10 MATERIAL REQUIREMENTS PLANNING (MRP-I) Material Requirements Planning is a computer based information system designed to handle ordering and scheduling of dependent-demand inventories (raw materials, sub assemblies, parts, components). A production plan for a specified number of finished products (usually over a monthly time period) in the form of a “master production schedule” is translated into requirements of component parts and raw materials working backward from the due date (need date in the production process) using lead times and other information (regarding how the product is built) to determine when to order and how much to order. Hence, requirements of end items generate the requirements for lower-level components which are broken down by planning periods so that ordering, fabrication and assembly can be scheduled for timely completion of end items while inventory levels are kept reasonably low. Objectives of MRP The objectives of material requirements planning in operations management are: 1. To improve customer service by meeting delivery schedules promised and shortening delivery lead times. 2. To reduce inventory costs by reducing inventory levels. 3. To improve plant operating efficiency by better use of productive resources. MANUFACTURING RESOURCES PLANING OR MRP-II When the capabilities of closed-loop MRP are extended to integrate financial, accounting, personnel, engineering and marketing information along with the production planning and control activities of basic MRP system, the resulting broad-based resource coordination system is known as manufacturing resource planning or MRPII. MRPII is the heart of corporate management information system for many companies, as it provides information about inventory investment levels, plant expansion needs and work force requirements, that is useful for coordinating marketing, financial, engineering and manufacturing efforts to achieve the company‟s overall business plans.
  11. 11. 11 MRP SYSTEM INPUTS 1. Master Production Schedule (MPS): The MPS specifies what end products are to be produced and when. The planning horizon should be long enough to cover the cumulative lead times of all components that must be purchased or manufactured to meet the end product requirements. 2. Bill of Material File or Product Structure File: This file provides the information regarding all the materials, parts and sub assemblies that go into the end product. The BOM file identifies each component by a unique part number and facilitates processing by exploding the end product requirements into components requirements. 3. Inventory Status File: The inventory status file gives complete and up-to-date information on the on-hand quantities, gross requirements, scheduled receipts and planned order releases for the item. It also includes other information such as lot sizes, lead times, safety stock levels and scrap allowances, etc. MRP SYSTEM OUTPUTS Two primary outputs are: 1. Planned order schedule which is a plan of the quantity of each material to be ordered in each time period. 2. Change in planned orders-i.e., modification of previous planned orders. The secondary outputs are: 1. Exception reports which list items requiring management attention to control. 2. Performance reports regarding how well the system is operating- e.g., inventory turnovers, percentage of delivery promises kept and stock out incidences. 3. Planning reports such as inventory forecasts, purchase commitment reports, etc.

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