Inventory

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INVENTORY MANAGEMENT

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Inventory

  1. 1. Inventory Chapter 6
  2. 2.  Inventory - a stock or store of goods - a list of goods on hand Kinds of Inventory:
  3. 3. Inventory  Inventory Functionality and Definitions  Inventory Carrying Cost  Planning Inventory  Managing Uncertainty  Inventory Management Policies  Inventory Management Practices
  4. 4. Inventory Functionality and Definitions  Inventory management is risky.  Typical measures of inventory exposure:  Time duration  Depth  Width of commitment  For manufacturer  long-term risk  For wholesaler  Assortment of merchandise  For retailer  velocity of buying and selling  Emphasis on inventory turnover
  5. 5. Functions of Inventory  To meet the anticipated customer demand  To smooth production requirements  To decouple operations  To protect against stockouts  To hedge against price increases  To permit operations  To take advantage of quantity discounts
  6. 6. 4 Prime Functions of Inventory
  7. 7.  Inventory policy  Service level  Average inventory  Average inventory across multiple performance cycles Inventory Definitions
  8. 8. Inventory Policy  Consists of guidelines concerning what to purchase or manufacture, when to take action, and in what quantity  Concerns inventory management practice
  9. 9. Service level  A performance target specified by management  Measured in terms of:  Performance cycle The elapsed time between the release of purchase order by a buyer to the receipt of shipment.  Case fill rate The percent of cases or units ordered that are shipped as requested  Line fill rate The percent of order lines filled completely  Order fill The percent customer orders filled completely
  10. 10. Service level
  11. 11. Average inventory  The materials, components, WIP, and fnished product typically stocked in the logistical system is called inventory and the typical amount across time is average inventory.  Order quantity  The amount ordered for replenishment  The difference between the maximum and minimum inventory levels.  Cycle inventory/base stock  Portion of average inventory that results from replenishment.  Average cycle inventory or base stock  The portion of average inventory that resullts from replinishment  Equals one-half order quantity
  12. 12.  Stock level  At a maximum following stock receipt from the supplier.  Safety stock  The majority of inventory in the typical logistics system  Ave. Inventory = ½ order quantity plus safety stock  Transit inventory -amount typically in transit between facilities or on order but not received.  Obsolete inventory -stock that is out-of-date or that has not experienced recent demand. Eventually donated, destroyed, or sold at a loss.  Speculative inventory - bought prior to need to hedge a currency exchange or to take advantage of a discount. Average inventory (continuation...)
  13. 13. Inventory Definitions: Inventory Cycle for Typical Product Average Inventory ½ order quantity ($40,000/2 or $20,000) + Safety Stock ($30,000) = $50,000 $30,000 Transit/Obsolete/Speculative/ Safety stock 1 2 $70,000 Maximum Inventory
  14. 14. Inventory Definitions: Average inventory across multiple performance cycles  Reorder point Defines when a replenishment order is initiated  Inventory turns Total sales divided by the average inventory  Economic Order Quantity (EOQ) Provides a specific quantity balacing the cost of orderingand the cost of maintaining average inventory
  15. 15. Inventory Definitions: Inventory Cycle with No Demand Uncertainty Average Inventory (Q/2) = 100 0 200 Order Arrives Days 40 60 Order Placed for 200 products 10 Reorder Point If sales occur at the rate of 10 products/day, it takes 20 days to sell 200 products Inventoryon hand
  16. 16. 0 200 60 Order Arrives 20 40 Order Placed for 200 products 10 Reorder Point Order Placed for 200 products 30 Reorder Point Inventory Definitions: Inventory Cycle with No Demand Uncertainty Assuming a work year of 240 days,12(240/20) purchases will be req. during the year. Therefore, over a period of 1 year 2400 (200*12) unit will be purchased. Inventory turnover will be 24 (2400 unit/100 units of ave. inventory) times.
  17. 17. Order Arrives 20 40 50 Order Placed for 100 products 10 Reorder Point 30 Average Inventory 50 products Reorder Point Reorder Point Reorder Point Reorder Point 0 100 Inventory Definitions: More Frequent Orders, Smaller Order Quantity Will have 24(240 days/10 days) purchases. Inventory turnover will be 48( 2400/50)times.
  18. 18. Ave. Inventory = 300 0 600 40 8020 60 100 120 Order Arrives Order Placed for 600 products Order Placed for 600 products Inventory Definitions: Less Frequent Orders, Larger Order Quantity
  19. 19. Inventory Carrying Cost  The expense associated with maintaining inventory  Calculated by multiplying annual inventory carrying cost percent by average inventory value.  Capital  Ranges from the prime interest rate to a higher managerially-determined percent  Taxes  A direct levy based on inventory level on a specific day of the year or average inventory level over a period of time
  20. 20.  Insurance An expense based upon estimated risk or loss over time Risks depends on the product and the facility storing the product.  Obsolescence Results from deterioration of product during storage Percent of ave. inventory value declared obsolete each year  Storage Facility expense related to product holding rather than product handling
  21. 21. Inventory Carrying Cost Components Element Average % % Ranges Cost of Capital 10.00% 4-40% Taxes 1.00 0.5-2 Insurance 0.05 0-2 Obsolescence 1.20 0.5-2 Storage 2.00 0-4 Totals 14.25% 5-50%
  22. 22. Planning Inventory  Inventory Planning consist of determining when and how much to order.  When to order is determined by average and variation in demand and replenishment.  How much to order is determined by the order quantity.  Inventory Control – the process of monitoring inventory status
  23. 23. When to Order (When No Demand/Performance Cycle Uncertainty) Reorder Point Formula: R = D X T R = Reorder Point in Units (of product) D = Average Daily Demand in Units (of product) T =Average Performance Cycle in Days (i.e., order cycle time, or the number of days between placing an order and receiving the order)
  24. 24. Reorder Point Formula R = D X T D = 20 products/day T = 10 days (time between placing order and receiving order) R = 20 X 10 Reorder Point = 200 products That is, an order is initiated whenever there are 200 products left in inventory
  25. 25.  Safety stock is necessary to accommodate uncertainty Reorder Point Formula R = D X T + SS  SS = Safety stock in units D = 20 products/day T = 10 days (time between placing order and receiving order) SS = 100 products R = 20 X 10 + 100 Reorder Point = 300 products That is, an order is initiated whenever there are 300 products left in inventory When to Order (When Demand/Performance Cycle is Uncertain)
  26. 26. How much to Order  The objective is to identify the ordering quantity that minimizes the total inventory carrying and ordering cost.  Significant cost are setup cost and holding cost, all other cost s, such as the inventory itself, is constant so minimizing the sum of setup and holding costs will also minimize total cost (TC).  Holding ( Carrying ) cost – the cost to keep or carry inventory over time.  Ordering ( Set Up ) cost – cost of the ordering process  EOQ – the replenishment practice that minimizes the combined inventory carrying and ordering cost
  27. 27.  EOQ = Economic Order Quantity  Co = Cost per Order (Ordering Cost)  Ci = Annual Inventory Carrying Cost %  D = Annual Product Sales (in units)  U = Cost per Product EOQ = 2Co D Ci U How Much to Order Economic Order Quantity (EOQ)
  28. 28. Alternate formula based on Heizer book  Q* = optimum number of units per order (EOQ)  D = Annual demand in units for the inventory items  S =Setup/Ordering cost for each order = Co  H = Holding/Carrying cost per unit per year = Ci * U Total Ordering cost = (D/Q) * S Total Carrying/Holding cost = (Q/2) * H (D/Q) * S = (Q/2) * H Q* = 2DS/H
  29. 29. EOQ = 2 * $19.00 * 2400 20% * $5.00
  30. 30.  EOQ = Economic Order Quantity  Co = $19.00 (ordering cost)  Ci = 20% (annual carrying cost %)  D = 2400 (annual number of products sold)  U = $5.00 (cost of each product) 302 rounded to 300 = 2 * $19.00 * 2400 20% * $5.00
  31. 31. How Much to Order Considering Transportation Rates  Order Quantity = 300 products per order  Number of orders placed per year = 2400/300 or 8  Ordering Cost per year = {( D/Q)*S} (2400 / 300)* $19 = $152.00  Inventory Carrying Costs per year = {(Q/2) * H} (300/2) * ($5.00 * 20%) = $150.00  Transportation Costs (per year) for Small Shipments:  $1.00 (per product) * 2400 (products purchased per year) = $2400.00  TOTAL COSTS = $150.00 + $152.00 + $2400.00 = $2702.00
  32. 32.  Order Quantity = 480 products per order  Number of orders placed per year = 2400/480 or 5  Ordering Cost per year = 5 orders * $19.00 = $95.00  Inventory Carrying Costs per year = 240 * $5.00 * 20% = $240.00  Transportation Costs (per year) for Large Shipments:  $0.75 (per product) * 2400 (products purchased per year) = $1800.00  TOTAL COSTS = $95.00 + $240.00 + $1800.00 = $2135.00 How Much to Order Considering Transportation Rates
  33. 33. Alternative 1  TOTAL COSTS (300 product order size)  $150.00 + $152.00 + $2400.00 = $2702.00 Alternative 2  TOTAL COSTS (480 product order size)  $95.00 + $240.00 + $1800.00 = $2135.00 How Much to Order Considering Transportation Rates
  34. 34. How Much to Order Considering Transportation Rates & Price/Quantity Discounts
  35. 35. How Much to Order Considering Transportation Rates & Price/Quantity Discounts  Order Quantity = 300 products per order  Number of orders placed per year = 2400/300 or 8  Ordering Cost per year = 8 orders * $19.00 = $152.00  Inventory Carrying Costs per year = 150 * $4.00 * 20% = $120.00  Transportation Costs (per year) for Small Shipments:  $1.00 (per product) * 2400 (products purchased per year) = $2400.00  Product Cost per year = 2400 * $4.00 = $9600.00  TOTAL COSTS = $120.00 + $152.00 + $2400.00 + $9600.00 = $12,272.00
  36. 36. How Much to Order Considering Transportation Rates & Price/Quantity Discounts  Order Quantity = 480 products per order  Number of orders placed per year = 2400/480 or 5  Ordering Cost per year = 5 orders * $19.00 = $95.00  Inventory Carrying Costs per year = 240 * $3.00 * 20% = $144.00  Transportation Costs (per year) for Large Shipments:  $0.75 (per product) * 2400 (products purchased per year) = $1800.00  Product Cost per year = 2400 * $3.00 = $7200.00  TOTAL COSTS = $95.00 + $144.00 + $1800.00 + $7200.00 = $9239.00
  37. 37. Alternative 1  TOTAL COSTS (300 product order size)  $152.00 + $120.00 + $2400.00 + $9600.00= $12,272.00 Alternative 2  TOTAL COSTS (480 product order size)  $95.00 + $144.00 + $1800.00 + $7200.00 = $9239.00 How Much to Order Considering Transportation Rates & Price/Quantity Discounts

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