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Inventory fundamental powerpoint

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Inventory fundamental powerpoint

  1. 1. Supply Chain Management Inventory Fundamentals
  2. 2. Inventory Fundamentals• Inventory = material + supply• For sale• Input or supply to the production process• Substantial part of total assets•20% to 60% of total assets on balance sheet • When used value is converted into cash •Improve cash flow and return on investment(ROI)
  3. 3. Inventory Fundamentals• Cost for carrying inventories - Increase operation cost - Decrease profit• Inventory management is responsible for - Planning inventory from raw material to customer - Controlling inventory from raw material to customer
  4. 4. Inventory Fundamentals1. Inventory results from production: finished goods2. Inventory support production: raw material work in process (WIP), etc.1 and 2 must be coordinatedInventory must be considered at each of the planning level - Production planning: over all - Master production schedule: end items - Material requirement planning: components & raw material
  5. 5. Inventory FundamentalsAggregate inventory management• Deals with managing inventory according to their classification - Raw material - Work in process (WIP - Finished good• Function of different inventories - not individual item level• Financially oriented - cost and benefits of carrying different classifications of inventories
  6. 6. Inventory FundamentalsInvolves 1. Flow and kind of inventory needed 2. Supply and demand pattern 3. Functions that inventories perform 4. Objective of inventory management 5. Cost associated with inventory
  7. 7. Inventory FundamentalsItem inventory management • Item level, not aggregate• Management establishes decision rule about inventory item• Rules - Which inventory items are most important - How individual items are to be controlled - How much to order at one time - When to place an order
  8. 8. Inventory FundamentalsFactors affecting inventory management decision1. Types of inventory based on the flow of material2. Supply and demand pattern 3.Function performed by inventory 4.Objective of inventory management 5.Inventory cost
  9. 9. Inventory Fundamentals1. Inventory and flow of material: • Raw material • Purchased item not processed yet • Supplier material • Components • Sub-assemblies • Work in process (WIP) • Raw material has been processed but not finished
  10. 10. Inventory Fundamentals Supplier Supplier Supplier Raw material/ Purchased part/ Material Work in process (WIP) Finished goods Warehouse Warehouse WarehouseCustomer Demand Customer Demand Customer Demand
  11. 11. Inventory FundamentalsInventory & flow of material-Continues • Finished goods • Ready to be sold as completed items • Factory storage • Warehouse • Distribution centers • Distribution inventories • Finished goods in the distribution system
  12. 12. Inventory FundamentalsInventory & flow of material-Continues • MRO supplies used in production that do not become part of the products such as hand tools, spare parts, die, drill bit, etc. • Maintenance • Repair • Operational
  13. 13. Inventory FundamentalsInventory & flow of material-Continues • Classification depends on production environment For example tire • Tire is finished goods for tire manufacturer • Tire is raw material for car manufacturer
  14. 14. Inventory Fundamentals2. Supply and demand pattern • If supply meet demand - no inventory • Demand must be predictable, stable and relatively constant over a long time period - zero inventory • Produce goods on a line - flow basis - matching production with demand - no inventory Raw material Work center Customer Zero Zero
  15. 15. Inventory Fundamentals2. Supply and demand pattern-continues •Large demand to justify setting up flowsystem • Demand is instable - varies • Lots or batch manufacturing • Workstations are organized by function • Work flow from workstation to workstation in lot • Inventory build up in • Raw material • Work in process (WIP) • Finished goods
  16. 16. Inventory Fundamentals3. Functions performed by inventory : • Decouple supply and demand • Buffer between supply and demand • Buffer between finished goods and customer demand • Buffer between finished goods and component availability
  17. 17. Inventory Fundamentals3. Functions performed by inventory - continue • Requirement for an operation and the output from the preceding operation • Parts and material to begin production and supplies of material
  18. 18. Inventory Fundamentals3. Functions performed by inventory - continue Classification of inventory by function: a) Anticipation inventory: • Build up in anticipation of future demand • Example: before peak selling season, promotion program, vacation, shut down, etc. • To help level production • To reduce cost of changing production rate
  19. 19. Inventory FundamentalsClassification of inventory by function - continues b) Fluctuation inventory (Safety stock): • Inventory is held to cover random, unpredictable fluctuation in supply and demand or in lead time • If demand or lead time is greater than forecast, a stock out occurs • Safety stock is carried to protect stock out
  20. 20. Inventory FundamentalsClassification of inventory by function - continues 2. Fluctuation inventory (Safety stock): • Prevent disruption in manufacturing or deliveries to customer Safety stock - buffer stock - reserve stock
  21. 21. Inventory FundamentalsClassification of inventory by function - continues3. Lot size inventory: • Lot size inventory - cycle inventory • Portion of inventory that depletes gradually as customer order received • Replenish cyclically when suppliers order are received
  22. 22. Inventory FundamentalsClassification of inventory by function - continues4. Transportation inventory: Transportation inventory - Pipeline inventory - movement inventory • Time needed to move goods from one location to another location • Example: supplier to manufacturer; plant to distribution centers, etc.
  23. 23. Inventory FundamentalsC4. Transportation inventory: I = t x A/ 365; I = average amount; A=annual demand; t = transit time, days I Cost; I t; Reduce transit time to reduce inventory and hence cost
  24. 24. Inventory FundamentalsClassification of inventory by function - continues4. Transportation inventory: Example: Delivery of goods from a supplier is in transit for ten days. If the annual demand is 5200 units, what is the average annual inventory in transit? I = 10 x 5200 / 365 = 142.5 units
  25. 25. Inventory FundamentalsClassification of inventory by function - continues5. Hedge inventory: • Commodities - Mineral - Oil - Grain • Buy and wait to sell when price rises • Buy at low cost, wait, sell on high price
  26. 26. Inventory FundamentalsClassification of inventory by function - continues6. MROs inventory:Maintenance, repair and operation / over haul • Support general operation and maintenance - Spare parts - Consumables - Stationer
  27. 27. Inventory Fundamentals3. Objective of inventory management: A. Maximum customer service B. Low cost plant operation C. Minimum inventory investment Maximum customer service: • Ability to satisfy customer needs • Availability of items when needed and a measure of inventory management effectiveness
  28. 28. Inventory Fundamentals3. Objective of inventory management- continues Maximum customer service: • Customers: who they are! • Purchaser • Distributor • Other plants • Workstations
  29. 29. Inventory Fundamentals3. Objective of inventory management- continues Maximum customer service: • Measurements of customer service • % of order shipped on schedule • % of line item shipped on schedule • Order days out of stock • Inventory help to maximize customer service by protecting against uncertainties • Carry extra inventories to meet uncertain demand
  30. 30. Inventory Fundamentals3. Objective of inventory management:- continues Low cost plant operations (4 ways) I.Allow operation with different rates of production to operate separately and more economically II. Allow level production of seasonal items - inventories build up in non- peak sale season
  31. 31. Inventory Fundamentals3. Objective of inventory management:- continues Low cost plant operations (4 ways) II.Allow level production of seasonal items - inventories build up in non-peak sale season, How? Reduced overtimeReduced training cost Reduced training cost Lower capacity requirement Reduced subcontracting cost
  32. 32. Inventory Fundamentals3. Objective of inventory management:- continues Low cost plant operations (4 ways) III. Allow longer production run • Lower setup cost • Setup cost is fixed: one unit or 1000 units • Increase in capacity • less setup • More run time • Bottleneck operation
  33. 33. Inventory Fundamentals3. Objective of inventory management:- continues Low cost plant operations (4 ways) IV. Allow to purchase in larger quantities • Lower ordering cost • Quantity discount
  34. 34. Inventory Fundamentals3. Objective of inventory management:- continues Inventories cost money, they must be balanced with I. Customer service:  Low inventory - high stock out  Lower level of customer service II.Cost in changing production level  Excess equipment  Overtime  Hiring and layoff  training
  35. 35. Inventory Fundamentals3. Objective of inventory management:- continues Inventories cost money, they must be balanced with III. Cost of placing order  Each order placed cost IV. Transportation cost  Small quantity cost more per unit Therefore, carry inventory if it cost less than not to carry
  36. 36. Inventory FundamentalsInventory costs:1. Item cost • landed price • purchase cost • cost to get it in plant • transportation • custom duties • insurance2. Carrying cost3. Ordering cost4. Stock out cost5. Capacity associated costs
  37. 37. Inventory FundamentalsInventory costs:1. Item cost2. Carrying cost • Cost of carrying volume of inventory • Capital cost • Storage cost • Space • Labor • equipment • Risk cost • Obsolescence: model change, out dated • Damage: in handling • Pilferage: lost, misplace, stray, stolen3. Ordering cost4. Stock out cost5. Capacity associated costs
  38. 38. Inventory FundamentalsInventory costs:1. Item cost2. Carrying cost3. Ordering cost • Associated with placing an order with a factory or supplier • Independent of quantity order • Depends on number of orders placed in a year • Production control cost * Setup time *Production loss * Tear down at the end of run • Lost capacity cost * Incurred when an order is placed * Order preparation * Expediting * Follow-up * Receiving * Authorizing payment * Receiving and paying invoice
  39. 39. Inventory FundamentalsInventory costs:1. Item cost2. Carrying cost3. Ordering cost: ExampleA company carry an average annual inventory of $2,000,000. If they estimate the cost of capital is 10%. Storage costs are 7% and risk costs are 6%. What does it cost per year to carry this inventory?
  40. 40. Inventory FundamentalsExample-continuesTotal cost of carrying inventory = 10% + 7% + 6%Total cost of carrying inventory = 23% Totalannual cost of carrying inventory = 23% x$2,000,000Total annual cost of carrying inventory = 0.23 x $2,000,000Total annual cost of carrying inventory = $460,000
  41. 41. Inventory FundamentalsOrdering cost: ExampleGiven the following annual costs, calculatethe average cost of placing one order.Production control salaries = $60, 000Supplies and operating expenses forproduction control department = $15,000Cost of setting up work centers for an order =$120 Order placed each year = 2000
  42. 42. Inventory FundamentalsOrdering cost: ExampleAverage cost = fixed cost/number of orders + variable costAverage cost = ($60, 000 + $15,000 )/2000 + $120Average cost = $37.50 + $120 = $157.50
  43. 43. Inventory FundamentalsInventory costs:1. Item cost2. Carrying cost3. Ordering cost4. Stock out cost • If demand during the lead time exceeds forecast we expect a stock out  Back order cost  Lost sale  Lost customer5. Capacity associated costs
  44. 44. Inventory FundamentalsInventory costs:1. Item cost2. Carrying cost3. Ordering cost4. Stock out cost5. Capacity associated costs • When output level is changed, following cost may incur i. Overtime v. Training ii. Hiring vi. Extra shift iii. Leveling production vii. Laying off iv. Carrying inventory
  45. 45. Inventory Fundamentals Quarter Quarter Quarter Quarter 1 2 3 4 TotalForecast demand 2,000 3,000 6,000 5,000 16,000Production 4,000 4,000 4,000 4,000 16,000Ending inventory 0 2,000 3,000 1,000 0 -Average inventory 1,000 2,500 2,000 500 -Inventory cost ($) $ 3,000 $ 7,500 $ 6,000 $1,500 $18,000
  46. 46. Inventory Fundamentals1. Capacity associated costs: Example Acompany makes and sells a seasonal product.Based on a sales forecast of 2000, 3000, 6000 and5000 per quarter, calculate a level production plan,quarterly ending inventory and average quarterlyinventory.If inventory carrying costs are $3 per unit per quarter, what is the annual cost of carrying inventory? Opening and ending inventories are zero.
  47. 47. Inventory FundamentalsFinancial statement and inventory:• Balance sheetAssets = Liabilities + Owner’s equity• Income statementIncome = Revenue - Expenses• Cash - flow analysis - Cash requires • To purchase raw material • Pay for production cost - Labor - overhead
  48. 48. Inventory FundamentalsFinancial statement and inventory:Example:a) If the owner’s equity is $1,000 and liabilities are $800, what are the assetsb) If the assets $1,000 and liabilities are $600, what is the owner’s equity?a) Assets = Liabilities + Owner’s equityAssets = $800 + $1,000 = $ 1,800)Owner’s equity = Assets - LiabilitiesOwner’s equity = $1,000 - $600 = $400
  49. 49. Inventory FundamentalsFinancial statement and inventory: continuesCash in - cash out > 0; self-finance• Income statementCash in - cash out < 0; borrowExample:Given the following data, calculate the gross margin and the net income.How much would profit increase if, through better material management, material costs are reduced by $50,000?
  50. 50. Inventory Fundamentals Example: continuesRevenue $1,500,000Direct labor $300,000Direct material $500,000 Notice, net incomeFactory overhead $400,000General and admin. (profit) of 33% Expenses $150,000Revenue $1,500,000 Revenue $1,500,000Cost of goods sold Cost of goods soldDirect labor $300,000 Direct labor $300,000Direct material $500,000 Direct material $450,000Factory overhead $400,000 $1,200,000 Factory overhead $400,000 $1,150,000Gross margin $300,000 Gross margin $350,000General and admin. General and admin. Expenses $150,000 Expenses $150,000Net income (profit) $150,000 Net income (profit) $200,000 33%
  51. 51. Inventory FundamentalsFinancial inventory performance measures: • Inventory - money tied up 1. Total inventory investment 2. Inventory turn ratio 3. Days of supply
  52. 52. Inventory FundamentalsFinancial inventory performance measures: continues Inventory turn ratio = Annual cost of goods sold / average inventory in $ - Higher is better If annual cost of goods sold is $1 million and average inventory is $500,000, then Inventory turn ratio = $1,000,000/$500,000 = 2
  53. 53. Inventory FundamentalsInventory turn ratio - continuesExample: a) What will be the inventory turn ratio if the annual cost of goods sold is $24 million a year and the average inventory is $6 million?Answer:Inventory turn ratio = Annual cost of goods sold / average inventory in $Inventory turn ratio = $24 million/$6 million = 4
  54. 54. Inventory FundamentalsInventory turn ratio - continuesExample: b) What would be the reduction in inventory if inventory turn ratio is increased to 12 times per year?Answer:average inventory in $ = Annual cost of goods sold / Inventory turn ratioaverage inventory = $24 million/ 12 =$2 million Reductionin inventory = $6 million - $ 2 million = $4 million
  55. 55. Inventory FundamentalsInventory turn ratio - continuesExample: c) If cost of carrying inventory is 25% of the average inventory, what will be the savings?Answer:Reduction in inventory = $6 million - $ 2 million = $4 millionSaving = $4 million x 25% = $4 million x 0.25 = $1 million
  56. 56. Inventory FundamentalsFinancial inventory performance measures: continues Days of supply = Inventory on hand / average daily usage - Lower is better Example: Inventory on hand is 9,000 units and annual usage is 48,000 units, there are 240 days per year average daily usage = 48,000/240 = 200 units Days of supply = 9000 / 200 = 45 days
  57. 57. Inventory FundamentalsMethods of evaluating inventory: (4) 1. FIFO - In rising prices, replacement is at higher prices than assumed cost - Does not reflect current price - Replacement is understated in rising price - Replacement is overstated in falling price 2. LIFO 3. Average cost 4. Standard cost
  58. 58. Inventory FundamentalsMethods of evaluating inventory: (4) 1. FIFO 2. LIFO - In rising prices, replacement is at current prices - Reflect current price - Replacement is current in rising price - Replacement is current in falling price 3. Average cost 4. Standard cost
  59. 59. Inventory FundamentalsMethods of evaluating inventory: (4) 1. FIFO 2. LIFO 3. Average cost - An average of all the prices paid for the article - Reflect average price - Replacement is average in rising price - Replacement is average in falling price 4. Standard cost
  60. 60. Inventory FundamentalsMethods of evaluating inventory: (4) 1. FIFO 2. LIFO 3. Average cost 4. Standard cost - Cost is determined before production begins - Cost = direct material + direct labor + overhead - Any difference between the standard cost and actual cost is stated as variance
  61. 61. Inventory FundamentalsABC Inventory Control: •Controlling individual items - What is the importance of inventory item? - How are they to be controlled? - How much should be ordered at one time? - When should an order be placed?
  62. 62. Inventory FundamentalsABC inventory classification system - Importance of an SKU - inventory item • $ value • scarcity - Level of control Pareto principle - 80-20 rule 1. A - 20% of items; 80% of $ value 2. B - 30% of items; 15% of $ value 3. C - 50% of items; 5% of $ value
  63. 63. Inventory FundamentalsSteps in making an ABC analysis: (3) 1. Establish item characteristics - $ value - scarcity 2. Classify items into groups 3. Apply a degree of control in proportion to importance
  64. 64. Inventory FundamentalsProcedure for classifying by annual $ values:(5 steps) 1. Determine annual usage 2. Multiply annual usage by its cost; total annual $ usage 3. List items according to their annual $ usage 4. Calculate the cumulative annual $ usage and cumulative percentage of the items 5. Examine the annual usage distribution and group the items into A, B and C groups based on annual percentage usage
  65. 65. Inventory FundamentalsABC Analysis: ExampleA company manufactures a line of ten items. Theirusage and unit costs are shown in the followingtable along with the annual usage.a.Calculate the annual usage of each itemsb. List the items according to their annual $ usagec. Calculate the cumulative annual dollar usage and the cumulative percent of itemsd. Group items into A, B and C classification
  66. 66. Inventory FundamentalsExample - continues (table) Part Number Unit usage Unit cost $ 1 1,100 2 2 600 40 3 100 4 4 1,300 1 5 100 60 6 10 25 7 100 2 8 1,500 2 9 200 2 10 500 1 Total 5,510
  67. 67. Inventory FundamentalsExample - continues (Answer a)) Part Number Unit usage Unit cost $ Annual $ usage 1 1,100 2 $2,200 2 600 40 $24,000 3 100 4 $400 4 1,300 1 $1,300 5 100 60 $6,000 6 10 25 $250 7 100 2 $200 8 1,500 2 $3,000 9 200 2 $400 10 500 1 $500Total 5,510 $38,250
  68. 68. Inventory FundamentalsExample - continues (Answer b), c) and d))
  69. 69. Inventory FundamentalsExample - continues (Answer b), c) and d))
  70. 70. Inventory FundamentalsExample - continues (Answer b), c) and d))Part Unit Unit Annual $ Cumulative Cumulative Cumulativ ClassNumber usage cost $ usage $ usage % $ usage e % items 2 600 40 $24,000 $24,000 62.75% 10.0% A 5 100 60 $6,000 $30,000 78.43% 20.0% A 8 1,500 2 $3,000 $33,000 86.27% 30.0% B 1 1,100 2 $2,200 $35,200 92.03% 40.0% B 4 1,300 1 $1,300 $36,500 95.42% 50.0% B 10 500 1 $500 $37,000 96.73% 60.0% C 3 100 4 $400 $37,400 97.78% 70.0% C 9 200 2 $400 $37,800 98.82% 80.0% C 6 10 25 $250 $38,050 99.48% 90.0% C 7 100 2 $200 $38,250 100.00% 100.0% C
  71. 71. Inventory FundamentalsControl based on ABC classification: (2 rules) 1. Have plenty of low $ value items - C items - 50% items - 5% cost - Keep safety stock - Order annually 2. Use the money and control effort to reduce the inventory of high value items - A items - 20% items - 80% cost - Deserve the tightest control - Frequent review
  72. 72. Inventory FundamentalsDifferent Controls:• A - items: High priority - Tightest control - Complete accurate record - Regular and frequent review - Frequent review of demand - Close follow up and expediting to reduce lead time
  73. 73. Inventory Fundamentals• B - items: Medium priority - Normal control - Good record - Regular attention - Normal processing

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