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Inventory Management


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Inventory Management

  1. 1. Managing Inventory for Profit Maximisation Anand Subramaniam
  2. 2. Key points <ul><li>Inventory Management Overview & Controls </li></ul><ul><li>Material Flows </li></ul><ul><li>Inventory Planning Models </li></ul><ul><li>Inventory Cost </li></ul><ul><li>Economic Ordering Cost </li></ul><ul><li>Minimum Quantity Calculation </li></ul><ul><li>Safety Stock </li></ul><ul><li>Inventory Counting </li></ul><ul><li>ABC Classification </li></ul>
  3. 3. Inventory Management Overview
  4. 4. <ul><li>To achieve satisfactory levels of customer service whilst keeping inventory costs within reasonable bounds. </li></ul>Overall Objective of Inventory Mngt.
  5. 5. <ul><li>Raw material </li></ul><ul><li>Work-in-progress </li></ul><ul><li>Maintenance / Repair / Overhaul (MRO) supply </li></ul><ul><li>Finished goods </li></ul>Types of Inventory
  6. 6. Inventory Classifications Inventory Process stage Demand Type Number & Value Other Raw Material WIP Finished Goods Independent Dependent A Items B Items C Items Maintenance Repair Overhaul .
  7. 7. <ul><li>Maximise inventory turnover </li></ul><ul><li>Minimise damage and waste while in inventory </li></ul><ul><li>Minimise handling and storage </li></ul><ul><li>Minimise out of stock situations (stockouts) </li></ul><ul><li>Minimise the after “best before date” cases </li></ul><ul><li>Minimise engineering/design/customer changes </li></ul><ul><li>Minimise time from request to shipping </li></ul><ul><li>Minimise ordering costs from producer to stock </li></ul><ul><li>Minimise ‘interest’ costs of holding materials </li></ul>Inventory Management Objectives
  8. 8. What are the functions of Inventory? <ul><li>Smooth seasonal production requirements </li></ul><ul><li>Protect against stockouts </li></ul><ul><li>Hedge against price increases </li></ul><ul><li>To ”decouple” or separate various parts of the production process </li></ul><ul><li>To provide a stock of goods that will provide a “selection” for customers </li></ul><ul><li>To take advantage of quantity discounts </li></ul>
  9. 9. <ul><li>Where should stores be placed & Why </li></ul><ul><li>What should be stored there & Why </li></ul><ul><li>How much of an item should be stored & Why </li></ul><ul><li>How much safety stock should be stored & Why </li></ul><ul><li>How long before an order is placed (safety time) </li></ul><ul><li>How to find and keep track of what is stored </li></ul><ul><li>How to move/use items from different stores </li></ul><ul><li>What is the Min / Max for each item & Why </li></ul>Decisions to Make
  10. 10. <ul><li>Level of customer service </li></ul><ul><li>Costs of ordering inventories </li></ul><ul><li>Cost of carrying inventories </li></ul><ul><li>Good personnel selection, training, and discipline </li></ul><ul><li>Tight control of incoming shipments </li></ul><ul><li>Effective control of all goods leaving the facility </li></ul>Inventory Controls
  11. 11. <ul><li>Inventory is a significant asset and for many companies the largest asset. </li></ul><ul><li>Inventory is central to the main activity of merchandising and manufacturing companies. </li></ul><ul><li>Mistakes in determining inventory cost can cause critical errors in financial statements. </li></ul><ul><li>Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees. </li></ul>Why inventory controls are important?
  12. 12. <ul><li>If merchandise inventory is overstated </li></ul><ul><li>Cost of merchandise sold is . . understated </li></ul><ul><li>Gross profit and net income are . . overstated </li></ul><ul><li>Total stockholders’ equity is . . overstated </li></ul>Effect of inventory errors on Financials STOCK-HOLDERS’ EQUITY Merchandise Inventory Cost of Merchandise Sold ASSETS COSTS & EXPENSES Net Income REVENUES LIABILITIES
  13. 13. <ul><li>Carrying Too Much Inventory </li></ul><ul><li>Increased overhead costs </li></ul><ul><li>Increased financial holding costs </li></ul><ul><li>Increased risk of loss of market value </li></ul><ul><li>Decreased inventory flexibility </li></ul><ul><li>Increased inventory shrinkage </li></ul><ul><li>Carrying Too Little Inventory </li></ul><ul><li>Increased risk of lost sales </li></ul><ul><li>Increased ordering costs </li></ul><ul><li>Increased risk of supplier price increases </li></ul><ul><li>Increased exposure to non delivery </li></ul><ul><li>Decreased bulk order discounts </li></ul>Inventory Management Challenges
  14. 14. <ul><li>Lead time : time interval between ordering and receiving the order </li></ul><ul><li>Holding (carrying) costs : cost to carry an item in inventory for a length of time, usually a year </li></ul><ul><li>Ordering costs : costs of ordering and receiving inventory </li></ul><ul><li>Shortage costs : costs when demand exceeds supply </li></ul><ul><li>Independent demand - demand for item is independent of demand for any other item </li></ul><ul><li>Dependent demand - demand for item is dependent upon the demand for some other item </li></ul>Inventory Terms
  15. 15. <ul><li>What is on hand and where? </li></ul><ul><li>Who wants it and how much do they require? </li></ul><ul><li>How much is on order and who from? </li></ul><ul><li>When will it arrive? </li></ul><ul><li>What is Available To Promise (ATP)? </li></ul><ul><li>What were your past Stock Holdings? </li></ul><ul><li>What were your past sales? </li></ul>Does your current system tell you…..
  16. 16. <ul><li>Allow you to create a demand forecast </li></ul><ul><li>Advise you of the current lead time </li></ul><ul><li>Calculate your manufacturing lead time </li></ul><ul><li>Allow you to classify inventory items into ABC classes </li></ul><ul><li>Let you keep an eye on your business while on business trips </li></ul>Does your current system also…..
  17. 17. Material Flow
  18. 18. Manufacturing Suitability Process Discrete Make to Stock Consumer Packaged Goods Batch Food Products Pharmaceuticals Oil & Gas Process Repetitive Electronic Components Configurable Products Make to Order Assemble to Order Personal Computers Automotive Components Aerospace Project Engineer to Order Custom Products & Equipment
  19. 19. Material Flow Cycle
  20. 20. <ul><li>Run time : Job is at machine and being worked on </li></ul><ul><li>Setup time : Job is at the work station, and the work station is being &quot;setup.&quot; </li></ul><ul><li>Queue time : Job is where it should be, but is not being processed because other work precedes it. </li></ul><ul><li>Move time : The time a job spends in transit </li></ul><ul><li>Wait time : When one process is finished, but the job is waiting to be moved to the next work area. </li></ul><ul><li>Other: Moving stock from delivery to the actual warehouse shelves. </li></ul>Other Wait Time Move Time Queue Time Setup Time Run Time Input Cycle Time Output Material Flow Cycle - Details
  21. 21. Inventory Planning Models
  22. 22. <ul><li>Fixed order-quantity models - EOQ </li></ul><ul><li>Probabilistic models </li></ul><ul><li>Fixed order-period models </li></ul><ul><ul><li>Minimum Quantity </li></ul></ul><ul><ul><li>Safety Stock </li></ul></ul><ul><li>Min / Max models </li></ul>Help answer the inventory planning questions! Inventory Models
  23. 23. Inventory Cost
  24. 24. <ul><li>Holding costs - associated with holding or “carrying” inventory over time </li></ul><ul><li>Ordering costs - associated with costs of placing order and receiving goods </li></ul><ul><li>Setup costs - cost to prepare a machine or process for manufacturing an order </li></ul>Inventory Costs
  25. 25. <ul><li>Obsolescence </li></ul><ul><li>Insurance </li></ul><ul><li>Extra staffing </li></ul><ul><li>Interest </li></ul><ul><li>Pilferage </li></ul><ul><li>Damage </li></ul><ul><li>Warehousing </li></ul>Holding / Carrying Costs
  26. 26. <ul><li>More units must be stored if more are ordered </li></ul>Purchase Order Description Qty. Microwave 1 Order quantity Why Holding Costs Increases? Purchase Order Description Qty. Microwave 1000 Order quantity
  27. 27. <ul><li>Category </li></ul><ul><li>Housing costs (building rent, depreciation, operating cost, taxes, insurance) </li></ul><ul><li>Material handling costs (equipment, lease or depreciation, power, operating cost) </li></ul><ul><li>Labor cost from extra handling </li></ul><ul><li>Investment costs (borrowing costs, taxes, and insurance on inventory) </li></ul><ul><li>Pilferage, scrap, and obsolescence </li></ul><ul><li>Overall carrying cost </li></ul><ul><li>Cost as a </li></ul><ul><li>% of Inventory Value </li></ul><ul><li>6% (3 - 10%) </li></ul><ul><li>3% (1 - 3.5%) </li></ul><ul><li>3% (3 - 5%) </li></ul><ul><li>11% (6 - 24%) </li></ul><ul><li>3% (2 - 5%) </li></ul><ul><li>26% </li></ul>Inventory Holding Costs (Example)
  28. 28. <ul><li>Supplies </li></ul><ul><li>Forms </li></ul><ul><li>Order processing </li></ul><ul><li>Clerical support </li></ul>Order Costs
  29. 29. <ul><li>Cost is spread over more units </li></ul><ul><li>Example: You need 1000 microwave ovens </li></ul>Why Order Costs Decreases? Purchase Order Description Qty. Microwave 1 Purchase Order Description Qty. Microwave 1 Purchase Order Description Qty. Microwave 1 Purchase Order Description Qty. Microwave 1 1 Order (Postage $ 0.33) 1000 Orders (Postage $330) Order quantity Purchase Order Description Qty . Microwave 1000
  30. 30. <ul><li>Clean-up costs </li></ul><ul><li>Re-tooling costs </li></ul><ul><li>Adjustment costs </li></ul>Setup Costs
  31. 31. <ul><li>Holding costs - associated with holding or “carrying” inventory over time </li></ul><ul><li>Ordering costs - associated with costs of placing order and receiving goods </li></ul><ul><li>Setup costs - cost to prepare a machine or process for manufacturing an order </li></ul>Inventory Costs
  32. 32. Economic Order Quantity
  33. 33. <ul><li>How much should you order? </li></ul><ul><li>Balances cost of ordering too much, too little </li></ul><ul><li>Too much – carrying costs – hold more </li></ul><ul><li>Too little – ordering costs – order more </li></ul><ul><li>Minimize annual costs of holding and ordering </li></ul>Why EOQ?
  34. 34. <ul><li>What must firms balance? </li></ul><ul><li>EOQ attempts to answer what questions? </li></ul><ul><ul><li>How much inventory should we order? </li></ul></ul><ul><ul><li>When do we place the inventory order ? </li></ul></ul>Economic Order Quantity - EOQ costs carrying too much inventory costs carrying too little inventory <ul><li>EOQ attempts to balance these costs: </li></ul><ul><ul><li>overhead costs, holding costs, </li></ul></ul><ul><ul><li>risk of lost market values, shrinkage </li></ul></ul>
  35. 35. A = The annual usage in units S = The overhead cost of placing one order C = The unit cost i = The carrying cost rate What is the formula for EOQ? What do the terms mean? Calculating EOQ EOQ iC AS 2 
  37. 37. Minimum Quantity Calculation
  38. 38. When do we place the inventory order? What is the formula? <ul><li>Define Lead Time: </li></ul><ul><ul><li>time lag between initiating a purchase order and when inventory is delivered and ready for sale. </li></ul></ul>Minimum Quantity Calculation Minimum Quantity = Average lead time in days x Average daily sales + Safety Stock
  39. 39. TIME S T O C K L E V E L SAFETY STOCK LEVEL (SS) MQ LT USAGE ( U) = 10 UNITS / DAY LEAD TIME ( LT) = 5 DAYS SAFETY STOCK (SS) = 20 UNITS Minimum Quantity (MQ) = SS + ( LT x U ) = 20 + ( 5 X 10 ) = 70 UNITS MQ = user defined 20 40 70 Minimum Quantity - Example
  40. 40. <ul><li>Minimum Quantity - When the quantity on hand of an item drops to this amount, the item is reordered </li></ul><ul><li>Safety Stock - Stock that is held in excess of expected demand due to variable demand rate and/or lead time. </li></ul><ul><li>Service Level - Probability that demand will not exceed supply during lead time. </li></ul>When to Reorder with EOQ Policy
  41. 41. Safety Stock
  42. 42. <ul><li>Safety stock and safety lead time are both hedges . </li></ul><ul><li>Safety lead time is more based on the uncertainty in the timing rather than the quantity. </li></ul><ul><li>Safety stock tends to be used in MRP where uncertainty about quantities is the problem – scrap. </li></ul>Safety Stock & Safety Lead Times
  43. 43. <ul><li>Not all demand is dependent – spares may have a service requirement that has an independent demand. </li></ul><ul><li>Variable lead times form suppliers due to uncertainty. </li></ul><ul><li>Firms may experience machine breakdowns, scrap or last minute customer changes . </li></ul>Safety Stock Reasons - Components
  44. 44. LT Time Expected demand during lead time Maximum probable demand during lead time MQ Quantity Safety stock Determining Safety Stock
  45. 45. <ul><li>Safety stock set high because of a one time event </li></ul><ul><li>Safety stock still active on an obsolete item </li></ul><ul><li>Safety stock levels inconsistent. </li></ul>Safety Stock Challenges
  46. 46. EOQ MQ Safety Stock Inventory (Units) 3 days 6 days 9 days 12 days Average Lead Time (3 days) MQ with Safety Stock EOQ, Minimum, Safety Stock Levels
  47. 47. Inventory Counting
  48. 48. <ul><li>Cyclical / Perpetual Inventory System </li></ul><ul><li>A system that keeps track of removals from inventory continuously, thus monitoring current levels of each item </li></ul><ul><li>Periodic System </li></ul><ul><li>A system that physical count of items made at periodic intervals </li></ul>Inventory Counting Systems
  49. 49. <ul><li>Physically counting a sample of total inventory on a regular basis </li></ul><ul><li>Used often with ABC classification </li></ul><ul><ul><li>Items counted most often (e.g., daily) </li></ul></ul>Cycle Counting Systems
  50. 50. <ul><li>Eliminates shutdown and interruption of production necessary for annual physical inventories </li></ul><ul><li>Eliminates annual inventory adjustments </li></ul><ul><li>Provides trained personnel to audit the accuracy of inventory </li></ul><ul><li>Allows the cause of errors to be identified and remedial action to be taken </li></ul><ul><li>Maintains accurate inventory records </li></ul>Advantage of Cycle Counting
  51. 51. ABC Classification
  52. 52. <ul><li>Classifying inventory according to some measure of importance and allocating controls efforts accordingly. </li></ul><ul><ul><li>A - very important </li></ul></ul><ul><ul><li>B - mod. important </li></ul></ul><ul><ul><li>C - least important </li></ul></ul>Annual $ volume of items A B C High Low Few Many Number of Items ABC Classification Systems
  53. 53. <ul><li>Divides on-hand inventory into 3 classes </li></ul><ul><ul><li>A class, B class, C class </li></ul></ul><ul><li>Basis is usually annual $ volume </li></ul><ul><ul><li>$ volume = Annual demand x Unit cost </li></ul></ul><ul><li>Policies based on ABC analysis </li></ul><ul><ul><li>Develop class A suppliers more </li></ul></ul><ul><ul><li>Give tighter physical control of A items </li></ul></ul><ul><ul><li>Forecast A items more carefully </li></ul></ul>ABC Analysis – Basis & Policy
  54. 54. % of Inventory Items Classifying Items as ABC 0 20 40 60 80 100 0 50 100 % Annual $ Usage A B C Class % $ Vol % Items A 80 15 B 15 30 C 5 55
  55. 55. <ul><li>Inventory Management Overview & Controls </li></ul><ul><li>Inventory Planning Models </li></ul><ul><li>Inventory – EQO, Min / Max, Safety Stock </li></ul><ul><li>Inventory Counting / ABC Classification </li></ul>Recap