Ops management lecture 8 inventory management

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Ops Management - Lecture 8 Inventory Management

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Ops management lecture 8 inventory management

  1. 1. Chapter eightInventory management
  2. 2. Learning objectives• Identify and describe classification systems, particularly ABC analysis• Understand the importance of record accuracy• Explain cycle counting• Discuss the impact of independent and dependent demand on inventory• Identify the costs involved in inventory holding• Define the term ‘inventory’• List reasons for holding inventory
  3. 3. Learning objectives (cont.)• Discuss the main requirements for effective inventory management• Describe and use basic economic order quantity models• Understand periodic and perpetual review systems• Describe and use the quantity discount model and reorder point model• Appreciate the need for buffer stock in inventory management• Appreciate the need for keeping inventory• Explain the importance of service levels in inventory management.
  4. 4. 8.1 Introduction• Inventory = stockpile or store of goods• Type of business determines inventory type• Inventory: one of the most expensive assets• Good indicator – number of times inventory is turned.
  5. 5. 8.2 The nature and importance of holding inventory• ROI• Larger the reduction in holding inventory, the higher the ROI• Manufacturing organisations hold: – Raw materials – WIP – Finished goods – Replacement parts
  6. 6. 8.2 The nature and importance of holding inventory (cont.) COMMON REASONS FOR KEEPING INVENTORY Decouple production process There is an insecure supply of raw materials To distance organisation from uncertain demand To facilitate wide variety of products To take advantage of supplier discounts To avoid price increases Items are in transit To smooth production requirements To prevent stock-outs occurring To take advantage of ordering cycles
  7. 7. 8.2 The nature and importance of holding inventory (cont.)• Objective function of inventory control – Satisfaction of customers – Management of inventory costs Two types of stockholding Overstocking – too much inventory – large funds tied up Understocking – too little inventory – late deliveries
  8. 8. 8.2 The nature and importance of holding inventory (cont.)• Inventory types: – Inventory of raw materials – not yet transformed into finished goods – WIP inventory – in process but not completed – Maintenance, repair and operating inventory – machine parts etc. – Finished goods inventory – goods that are ready for delivery
  9. 9. 8.2 The nature and importance of holding inventory (cont.)• Control and turnover of inventory• Lower the turnover the poorer the performance of the inventory control function
  10. 10. 8.2 The nature and importance of holding inventory (cont.)
  11. 11. 8.2 The nature and importance of holding inventory (cont.)Average world wide trends:-ITR = 3 or 4 timesLean manufacturing as much as 30 times!
  12. 12. 8.2 The nature and importance of holding inventory (cont.)If we assume the following:-R250,000 of average inventory = FGIR250,000 of average inventory = RMIR500,000 of average inventory = WIPR2,000,000 labour and overhead costs to transform raw materialsto finished goodsR2,500,000 = Purchasing materials costR750,000 – cost of carrying FGIR2,000,000 labour and overhead costs to transform raw materialsto finished goodsCalculate TWIP,TRM & TFGI
  13. 13. 8.2 The nature and importance of holding inventory (cont.)ASSUMPTIONSR250,000 = FGIR250,000 = RMIR500,000 = WIPR2,500,000 = Purchasingmaterials costR750,000 – cost of carrying FGIR2,000,000 labour and overheadcosts to transform raw materialsto finished goods
  14. 14. 8.2 The nature and importance of holding inventory (cont.)ASSUMPTIONSR250,000 = FGIR250,000 = RMIR500,000 = WIPR2,500,000 = Purchasingmaterials costR750,000 – cost of carrying FGIR2,000,000 labour and overheadcosts to transform raw materialsto finished goods
  15. 15. 8.2 The nature and importance of holding inventory (cont.)ASSUMPTIONSR250,000 = FGIR250,000 = RMIR500,000 = WIPR2,500,000 = Purchasingmaterials costR750,000 – cost of carrying FGIR2,000,000 labour and overheadcosts to transform raw materialsto finished goods
  16. 16. 8.2 The nature and importance of holding inventory (cont.)ASSUMPTIONSR250,000 = FGIR250,000 = RMIR500,000 = WIPR2,500,000 = Purchasingmaterials costR750,000 – cost of carrying FGIR2,000,000 labour and overheadcosts to transform raw materialsto finished goods
  17. 17. 8.2 The nature and importance of holding inventory (cont.)• Methods utilised to reduce stocks • Reduction in line and store stock • A two-bin system • SILS (Supplier in-line sequencing) – all needed parts delivered to operative • Kanbans – cards or similar for each operating station to communicate demand • Milk runs – daily trips by suppliers • Supplier sub-assembly of components on the organisation premises
  18. 18. 8.3 Requirements for effective inventory management• Two basic functions: • Keeping track of the entire inventory • Deciding how much to order and when
  19. 19. 8.3 Requirements for effective inventory management (cont.)• Counting systems for inventory: • Periodic counting system – daily, weekly, monthly inventory counts – Small retail outlets – Results determine next order quantity • Perpetual counting system: – System updated every time an item is removed • Batch perpetual system • Online perpetual system • Barcode systems
  20. 20. 8.3 Requirements for effective inventory management (cont.) • Forecasting demand and information regarding lead time • Costs incurred when inventory is carried out: • Holding cost – cost incurred for the actual storage of inventory over a specific time period • Ordering cost - cost associated with ordering and receipt of goods such as suppliers, forms and clerical support • Shortage cost – Cost incurred when demand exceeds supply
  21. 21. 8.3 Requirements for effective inventory management (cont.) • HOLDING COST • Cost of insurance against theft/fire damage • Cost of interest for loans to build warehouse and stock it • Cost of depreciation of goods held in inventory • Obsolescence costs due to newer/better products coming into market • Opportunity costs because money is tied up in stock and can, therefore not be used for other, more profitable items • Usually expressed as a % of the selling price of product
  22. 22. 8.3 Requirements for effective inventory management (cont.)• HOLDING COSTTV sells for R5000.Holding cost is 4% ofselling price per annum.How much will it costorganisation to hold 1 TVin stock for 1 year?
  23. 23. 8.3 Requirements for effective inventory management (cont.) • ORDERING COST • Set up costs – cost of setting machinery for manufacturing • Labour cost • Lost time for production • Operations manager must ensure all procedures and processes running efficiently to reduce ordering costs
  24. 24. 8.3 Requirements for effective inventory management (cont.) • SHORTAGE COST – Cost of losing a sale due to unavailability of a product – The loss of goodwill of the customer – The cost of lost production – Downtime cost of lost production – Estimation of these costs is difficult
  25. 25. 8.3 Requirements for effectiveinventory management (cont.) • Classification systems for inventory • ABC analysis • Pareto principle: 80/20 Critical few; trivial many Use management effort to control critical few i.e. top 20% in value! Don’t always use monetary value of inventory item • H. Ford Dickie , developed ABC in 1951 • Class discussion (see Table 8.2 on page 202 of the textbook)
  26. 26. 8.3 Requirements for effectiveinventory management (cont.) • Need for accurate inventory records • Usually accuracy is between 1 & 3%
  27. 27. 8.3 Requirements for effectiveinventory management (cont.) • Cycle counting – confirm accuracy of inventory records by continuous audit • Counted on a continuous rather than batch basis • Rules most often used: – Count after a busy period – Count when the balance shows zero stock – Use ABC analysis to determine frequency of count – Count when inventory records show a positive balance but a stock out occurs
  28. 28. 8.3 Requirements for effectiveinventory management (cont.) • Cycle counting – CLASS EXERCISE CLASS INVENTORY POLICY ITEMS TO BE HOLDING COUNTED/DAY A B C
  29. 29. 8.3 Requirements for effectiveinventory management (cont.) • Cycle counting – CLASS EXERCISE CLASS INVENTORY POLICY ITEMS TO BE HOLDING COUNTED/DAY 20 A WORKING 2750 DAYS 60 B WORKING 3500 DAYS 120 C WORKING 5000 DAYS
  30. 30. 8.3 Requirements for effective inventory management (cont.)ADVANTAGES OF CYCLE COUNTINGEnsures accuracy of inventory recordsEnhances detection of errors and ensures remedial actiontaken timeouslyNo need to close plant to facilitate cycle countingOnly trained warehouse personnel should do counts – thisminimises errors
  31. 31. 8.3 Requirements for effectiveinventory management (cont.) • How to control service inventory • Pilferage • Inventory shrinkage • Measures: • Bar coding shipments • Magnetic tags • Staff selection
  32. 32. 8.3 Requirements for effectiveinventory management (cont.) • Advantages and disadvantages of holding inventory • see Table 8.5 on page 206
  33. 33. 8.4 Economic order quantity models• Used to decide how much to order• There are 3 models: • The basic EOQ model • The economic production quantity model • The quantity discount model
  34. 34. BASIC EOQ MODEL• Developed by FW Harris at Westinghouse in 1915• This same model and a number of variations are still used throughout industry today• A number of assumptions have to be made
  35. 35. BASIC EOQ MODEL Assumptions• No stock outs should happen if orders for inventory are placed at correct time• There is a known and constant lead time that never varies• Only two types of variable cost will incur: set up cost (cost of placing order) and holding cost• All demand is independent, constant, known and never varies• No discounts for quantity will be given• The entire inventory will be received at once and complete• There will be only one product involved and no interaction will take place with other products
  36. 36. 8.4 Economic order quantity models Q = order size in units H = holding cost D = annual demand Q = order size S = cost per order Q0 = Optimal order quantity
  37. 37. EOQ – Basic Model• Class exercise
  38. 38. EOQ – Basic Model• Most limiting factor of the basic EOQ model is assumption that demand will always be constant• Therefore more flexible continuous (Q or fixed order) system is used
  39. 39. EOQ – Continuous Model• Mistake many managers make is to ignore inventory quantities that are already on order• This system monitors inventory on hand on a continuous basis after each inventory transaction• When inventory reaches reorder point (RoP) an order for a fixed quantity is placed.
  40. 40. Continuous ModelR=m+s R = reorder points = zσ m = mean demand over a specific lead time s = safety inventory Z = no of std dev for a given service level Σ = std dev of demand over leadtime
  41. 41. BASIC EOQ MODEL #### D Annual Demand Quantity of the Product 1,000 Costs with EOQ P Purchase Cost per Unit 1.00 Average Annual Purchase Cost: 1,000.00 C Fixed Cost per Order 20.00 Average Annual Fixed Order Cost: 50.00 H Annual Holding Cost per Unit 0.25 Average Annual Holding Cost: 50.00 (warehouse space, refrig., ins., etc.) Total: 1,100.00 EOQ Economic Order Quantity 400.00 Try different order quantities: 500.00 (optimal order quantity) 450.00 Costs by Order Quantity 400.00 Inventory Level 350.00 300.00 250.00 Holding Cost 200.00 Ordering Cost Total Cost 150.00 100.00 50.00 0.00Since the demand will be satisfied with the unit purchase cost any way, it is discarded from the model. The cost in consideration is reduced to2 types: Holding Cost and Ordering Cost. The tradoff between these costs is optimized at the minimum point of the Total Cost Curve, i.e. EOQ.EOQ is the level of the inventory where ordering cost and carrying cost remains equal.
  42. 42. OTHER MODELS• Please read p 217 - 227
  43. 43. Class discussion• What is the link between inventory and supply management?
  44. 44. Summary• Nature and importance of holding inventory• Effective inventory system• EOQM.

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