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Inventory management

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  • 1. Inventory Management - Uday Bansode uday.bansode@rediffmail.com
  • 2. Introduction Constitute significant part of current assets A considerable amount of fund is required Effective and efficient management is imperative to avoid unnecessary investment Improper inventory management affects long term profitability and may fail ultimately 10 to 20% of inventory can be reduced without any adverse effect on production and sales by using simple inventory planning and control techniques
  • 3. Meaning and Function Meaning - Inventories are resources of any kind having an economic value. “Properly maintaining adequate stocks to ensure uninterrupted service” Function – Inventory functions as a bank and decouples successive stages of operations. Operating sub-systems – Materials, Manufacturing and Marketing Non-operating sub-systems – Finance and Personnel
  • 4. Need for inventory Inventory is held for transaction purposes. To maintain a given volume of sales to satisfy customers. As a precaution or contingency for increase in lead time or a consumption rate. To decouple the materials department from the consuming department.
  • 5. Scope and Importance New effective tools and techniques evolved for efficient management of inventories. Private and Public undertaking sectors can make savings in inventories by effecting internal and external economies. Savings can be achieved in – Material purchase by competitive bidding, value analysis Economic ordering Reducing deterioration Obsolescence in storage i.e. reducing working capital blocked up
  • 6. Inventory Problem Inventory problem is one of balancing various costs so that total cost should be minimized. These costs are :- Cost of ordering - Cost of carrying - Quotation or tendering Warehousing or storage Requisitioning Handling Order Placing Clerical and staff Transportation Insurance Receiving inspecting & Storing Interest Quality control Deterioration, wastage Clerical and staff Taxes Under stocking and Overstocking cost - Loss of sale Failure to meet delivery commitments
  • 7. Lead Time influences the Inventories “Lead time – Time between placing an order and receiving it” Influence of various types of lead time on inventory decisions are :- Administrative lead time – due to identification of needs and follow-up orders Manufacturing lead time – due to dependability on the supplier of the goods Transporting lead time – depends on the mode of transport and formalities Inspection lead time – arises due non-availability the standard to compare the quality of the received item.
  • 8. Techniques of Inventory Management 1. Selective Inventory Control 2. Setting up various stock levels 3. Systems of Inventory Control 4. Economic Ordering Quantity or E.O.Q. Formula 5. Re-order Point and Safety Stock 6. Application of Computers for Inventory 7. Just-in-Time Inventory Management 8. Inventory Ratio 9. Aging Schedule of Inventory 10. Inventory Audit
  • 9. 1. Selective Inventory Control Analysis and classification of inventory for effective inventory management :- Title Use Main use ABC (Always Better Control) Value of conception to control raw material, components and work-in-progress inventories in the business HML(High, Medium, Low) Material Unit price to control purchase XYZ Value of the items to review the inventories and their uses at in storage scheduled intervals VED(Vital, Essential, Criticality of the to determine the stocking level of the spare Desirable) componentparts FSN(Fast, Slow, Non moving) consumption pattern to control obsolescence of the component SDE(Scarce, Difficult, Easy to problems faced in lead time analysis and purchasing strategies obtain) procurement GOLF(Govt Ordinary, Local, source of the procurement strategies Foreign Sources) material SOS(Seasonal, Off-Seasonal) Nature of supplies procurement strategies for seasonal items
  • 10. Selective Inventory Control (contd..) ABC Analysis :- ABC (Always Better Control) – ABC analysis divides the total inventory into 3 classes A,B and C using the rupee volume, as follows – 'A' items are very important for an organization because of the high value of these items. „A‟ items – 20% of the items accounts for 70% of the annual consumption value of the items. 'B' items are important, but of course less important, than ‘A’ items and more important than ‘C’ items. Therefore ‘B’ items are intergroup items. „B‟ items - 30% of the items accounts for 25% of the annual consumption value of the items. 'C' items are marginally important. „C‟ items - 50% of the items accounts for 5% of the annual consumption value of the items.
  • 11. Selective Inventory Control (contd..) ABC Analysis :-
  • 12. Selective Inventory Control (contd..) ABC Analysis :-
  • 13. Selective Inventory Control (contd..) Advantages of ABC Analysis :- Control - Stocking a better mix of the right inventory allows a company to control over-supply and under-supply of important stock keeping units. Costs - Once a company has determined which items fall into each ABC category it can establish cost-reduction initiatives at the stock keeping units level. Improved service - ABC analysis provides a company with information to stock the right-mix of inventory. When a company has the right inventory at the right time it reduces backorders and unfilled orders. This has a positive impact on customer service and gives a competitive advantage to the company that uses this methodology. Warehouse - Implementing ABC inventory management in the warehouse reduces labor cost and increases productivity.
  • 14. 2. Setting up Various Stock Levels Maximum Level = Re-order Level – Expected minimum consumption in units during minimum weeks to obtain delivery + Re-order qty Example: Normal usage100 units per day. Max. usage130 units per day. Minimum usage70 units per day. Re-order period 25 to 30 days. Economic order quantity 5,000 units. Calculate maximum limit or level. In order to calculate maximum limit of stock we must calculate re-order point or re-order level first. Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-order = 130 30 = 39,000 units Calculation: Maximum limit or level = Re-order level or ordering point – Minimum quantity used in re-order period usage + Economic order quantity = 3900 – (70 25) + 5,000 = 7150 units
  • 15. Setting up Various Stock Levels (contd…) Minimum Level = Re-order Level - (Avg usage per period x Avg time to obtain delivery) Example: Normal usage100 units per day. Max usage130 units per day. Min. usage 70 units per day. Re-order period 25 to 30 days Calculate: minimum limit or level. To calculate minimum limit of materials we must calculate re-order point or re-order first. Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-order = 130 30 = 3,900 units Calculation: Minimum limit or level = Re-order level or ordering point – Average or normal usage Normal re-order period = 3900 – (100 27.5*) 1150 units *(25 + 30 ) / 2
  • 16. Setting up Various Stock Levels (contd…) Re-order Level = Max Re-order period x Max usage Example: Minimum daily requirement 800 units. Time required to receive emergency supplies 4 days. Avg daily requirement 700 units. Min. daily requirement 600 units. Time required for refresh supplies One month (30 days). Calculate ordering point or re-order level. Calculation: Ordering point = Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time = 800 30 = 24,000 units
  • 17. Setting up Various Stock Levels Various stock levels fixed to control Inventory holding are :- Avg Stock Level = Maximum Level + Minimum Level 2
  • 18. 3. Systems of Inventory Control The Main systems of Inventory control are :- a) Perpetual Inventory (Automatic Inventory) system – Main Functions - i. Recording store receipts and issues to determine at any time the stock in hand. ii. Continues verification of physical stock with reference to the balance recorded in the stores record. b) Double Bin (Fixed Order Quantity) System – i. Used for low consumption value items. ii. Ideal for items for which demand and lead time are regular. iii. Avoids necessity of taking physical inventories.
  • 19. 4. Economic Ordering Quantity or EOQ Formula Economic Order Quantity is one of the techniques of inventory control which minimizes total holding and ordering costs for the year. Definition of EOQ :- EOQ is essentially an accounting formula that determines at which the combination of order, costs and inventory carrying cost are at the least. EOQ Formula :- EOQ or D = √ 2Q(a) / c Where, Q = Annual requirements in units a = Unit cost of placing an order c = Annual carrying cost D = Optimum lot quantity or Batch Size
  • 20. Economic Ordering Quantity or EOQ Formula (contd..) Tabular presentation of Economic Order Qty of 200 Units No o f Orders Order Qty Avg Stock Holding Inventory carrying cost (Rs) Ordering cost (Rs.) Total Cost (Rs.) 1 40,000 20,000 4,000 10 4,010 2 20,000 10,000 2,000 20 2,020 3 13,333 6,667 1,333 30 1,363 4 10,000 5,000 1,000 40 1,040 5 8,000 4,000 800 50 850 10 4,000 2,000 400 100 500 15 2,667 1,334 267 150 417 20 2,000 1,000 200 200 400 25 1,600 800 160 250 410 30 1,333 667 133 300
  • 21. Economic Ordering Quantity or EOQ Formula (contd..) Cost of each article is one rupee. Annual demand is 40,000 units. Cost of carrying inventory is 20%. Cost per order is Rs. 10/- Using the formula :- D = √ 2Q(a) / c = √2x10x40,000 / 1x0.20 D = √40,00,000 D = 2,000 units Here, EOQ is 2,000 units. When EOQ is 2,000 units, the no. of orders to be placed in a year is 20 and the total cost is Rs. 400/- ( ordering and inventory carrying cost are the same)
  • 22. 5. Re-order Point & Safety Stock Formula - Re-order point = Average Daily usage x Lead Time in days + Safety Stock Safety Stock – extra inventory held as a protection against possibility of a stockout.
  • 23. 6. Application of Computers for Inventory Advantages - Immense scope in areas like Inventory Management Saving Time Speed and Efficiency Document Generation Timely Data Disadvantages – Reliance on Technology Expense Risk of fraud
  • 24. 7. Just-in-Time ( JIT ) Inventory Management JIT is aimed at monitoring the inventory process in such a manner as to minimize the costs associated with inventory control and maintenance. An inventory strategy companies employ to increase efficiency and decrease waste by receiving goods only as they are needed in the production process, thereby reducing inventory costs. Lower Warehouse Cost Better Supply Chain Management Better Customer Satisfaction Less Waste
  • 25. 8. Inventory Ratio – Inventory Turnover Ratio This ratio is used to evaluate the performance of the inventory function :- ITR = Cost of sales during the period/Avg tock held during the period where, cost of sales means sales minus gross profit and avg. stock indicates yearly avg.(average of opening and closing inventory) Analysis - - it is used to measure the inventory management efficiency of a business. - a higher value indicates better performance and lower value means inefficiency in controlling inventory levels. - a lower inventory turnover ratio may be an indication of overstocking which may pose risk of obsolescence and increased inventory holding costs.
  • 26. Inventory Ratio – Inventory Turnover Ratio (contd…) Example: During the year ended December 31, 2010 Loud Corporation sold goods costing $324,000. Its average stock of goods during the same period was $23,432. Calculate the company's inventory turnover ratio. Formula - ITR = Cost of sales during the period/Avg tock held during the period Solution Inventory Turnover Ratio = $324,000 / $23,432 = 13.83
  • 27. 9. Aging Schedule of Inventory Classification of inventories in accordance with age (days) assist in identifying inventories which are moving slowly into production or sale. Aging Schedule of Inventory as on 31 December 2011 Age Classification (days) Dt of Purchase/ Mfg Amount (Rs.) % of Total 0-20 December 11 10,000 20 21-40 December 7 5,000 10 41-60 November 21 3,000 6 61-80 November 5 25,000 50 81 and above October 20 7000 14 Total 50,000 100
  • 28. 10. Inventory Audit Aspects of Inventory Audit:- i. Testing and appraisal of policy pursued for inventory forecasting, planning and control ii. Appraisal of inventory valuation method iii. Testing and appraisal of inventory forecasting and planning models iv. Testing and appraisal of control aspects v. Testing the maintenance aspects of inventory & inventory records
  • 29. Inventory Audit (contd..) Inventory Audit Process of manufacture Work-in- progress Finished goods By-products and scrap Raw materials Stores and spare parts Auditor’s observation & conclusion
  • 30. Inventory Audit (contd…) Checking points for Auditing – i. process of manufacture – auditor should be aware of technical aspects of process of manufacture of main products and by-products and scraps. ii. Raw Materials – auditor should ascertain that SOPs are followed for purchasing, consuming raw material and also it should be technically evaluated. iii. Stores and Spares – procurement and utilization of stores and spares should be done for effective savings. Redundant investment should be audited. iv. Auditors observations and conclusions
  • 31. Inventory Audit (contd…) Checking points for Auditing – iv. Auditors observations and conclusions – Cost auditor should observe following with respect to the inventory audit :- a) whether firm’s funds have been used in a negligent or inefficient manner. b) factors which could have controlled due to inventory but not done resulted in increase in cost of production. c) whether contracts/agreements related to purchase/selling of inventory items had any undue benefits. d) possibility of improvement in performance offering scope for cost reduction and increase in productivity. e) whether improved inventory policies will be useful for effective savings.
  • 32. Case Study - McDonald's Situation:- There are multiple warehouses (Distribution Centers) located in India and there exist common suppliers for each product. Also, these suppliers are located across the country. Warehouses order as per their requirement. Since the per trip loads are not enough to send a dedicated truck from supplier to each warehouse, receiving on-time deliveries and food safety of the products was a challenge. This had affected inventory holding in warehouses leading to higher inventory carrying cost, high inventory days, threat of stock-out situation and in-transit damages, safety of food items in transit and higher inbound cost. The need to transport products in a cost effective manner and ensure on-time availability without compromising on the integrity of the food products, was identified.
  • 33. Case Study - McDonald's Solutions Strategy:- Ensure consolidation of stock at the nearest warehouse and move full truck loads. To make it happen following steps were taken: Movement of full truck load (consolidated load from multiple warehouses) from supplier to the nearest warehouse. Flexibility of consolidated movement viz. Freezer / Dry, Chiller / Dry, etc in multi-temperature trucks. Movement of stocks directly from vendor to the consumption warehouse in case of high volume / fast moving products. Planned pickup and delivery from vendors at least 15 days in advance to ensure capacity utilization. Fixed schedule of movement from consolidation warehouse to the respective warehouses on Full Truck Load (FTL) basis. Inventory days and safety stock maintained in line with the scheduled movement.
  • 34. Case Study - McDonald's Results:- Assured supply of goods, by optimizing inventory and frequency of delivery. Cost benefit due to optimization of truck load. Assured safety of products in transit. Inventory under control i.e. reduced inventory holding from 20 days to 8 days. Reduction in Inventory carrying cost.
  • 35. Thank You