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As the cost of logistics increases retailers and manufacturers are looking to inventory management as a way to control costs. Inventory is a term used to describe unsold goods held for sale or raw materials awaiting manufacture. These items may be on the shelves of a store, in the backroom or in a warehouse miles away from the point of sale. In the case of manufacturing, they are typically kept at the factory. Any goods needed to keep things running beyond the next few hours are considered inventory.
What is Inventory Management Inventory management simply means the methods you use to organize, store and replace inventory, to keep an adequate supply of goods while minimizing costs. Each location where goods are kept will require different methods of inventory management. Keeping an inventory, or stock of goods, is a necessity in retail. Customers often prefer to physically touch what they are considering purchasing, so you must have items on hand. In addition, most customers prefer to have it now, rather than wait for something to be ordered from a distributor. Every minute that is spent down because the supply of raw materials was interrupted costs the company unplanned expenses.
What is Inventory Control Inventory control is the technique of maintaining the size of the inventory at some desired level keeping in view the best economic interest of an organization.
Type of Inventory Reason for holding the Inventory(1) Raw materials To reap the price advantage available on seasonal raw materials.(2) Work in progress To balance the production flow.(3) Ready made components When the components are bought rather than made.(4) Scraps They are disposal of in bulk.(5) Finished Goods Lying in stock rooms and waiting dispatches
Purpose of inventory management ◦ Stocking the RIGHT PRODUCT ◦ Able to LOCATE the products ◦ Maintain OPTIMUM LEVEL of inventory
Reasons to Hold Inventory Meet variations in customer demand: ◦ Meet unexpected demand ◦ Smooth seasonal or cyclical demand Pricing related: ◦ Temporary price discounts ◦ Hedge against price increases ◦ Take advantage of quantity discounts Process & supply surprises ◦ Internal – upsets in parts of or our own processes ◦ External – delays in incoming goods
Objective of Inventory Management To maintain a optimum size of inventory for efficient and smooth production and sales operations To maintain a minimum investment in inventories to maximize the profitability The 5 R’s: Effort should be made to place an order at the right time with right source to acquire the right quantity at the right price and right quality
An Effective Inventory Management Should … Ensure a continuous supply of raw materials to facilitate uninterrupted production Maintain sufficient stocks of raw materials in periods of short supply and anticipate price changes Maintain sufficient finished goods inventory for smooth sales operation, and efficient customer service Minimize the carrying cost and time Control investment in inventories and keep it at an optimum level
An Optimum Inventory Level Involves Three Types of CostsOrdering costs:- Carrying costs:- Quotation or tendering Warehousing or storage Requisitioning Handling Order placing Clerical and staff Transportation Insurance Receiving, inspecting and storing Interest Quality control Deterioration, shrinkage, Clerical and staff evaporation and obsolescenceStock-out cost Taxes Loss of sale Cost of capital Failure to meet delivery commitments
Dangers of Over-investment Unnecessary tie-up of firm‟s fund and loss of profit – involves opportunity cost Excessive carrying cost Risk of liquidity- difficult to convert into cash Physical deterioration of inventories while in storage due to mishandling and improper storage facilities
Dangers of Under-investment Production hold-ups – loss of labor hours Failure to meet delivery commitments Customers may shift to competitors which will amount to a permanent loss to the firm May affect the goodwill and image of the firm
Maximum Stock LevelQuantity of inventory above which should not be allowed to bekept. This quantity is fixed keeping in view the disadvantages ofoverstocking;Factors to be considered: Amount of capital available. Godown space available. Possibility of loss. Cost of maintaining stores; Likely fluctuation in prices; Seasonal nature of supply of material; Restriction imposed by Govt.; Possibility of change in fashion and habit.
Minimum Stock Level This represents the quantity below which stocks should not be allowed to fall . The level is fixed for all items of stores and the following factors are taken into account: 1.Lead time- 2. Rate of consumption of the material during the lead time.
Re-ordering Level It is the point at which if stock of the material in store approaches, the store keeper should initiate the purchase requisition for fresh supply of material. This level is fixed some where between maximum and minimum level.
Managing Small Items Inventory control is simply knowing how much inventory you have. It is a means to control loss of goods. Businesses that use large quantities of small items often use an “80/20” or ABC rule in which they keep track of 20 percent of the largest value inventory items and use it to represent the whole. “A” items are the top valued 20 percent of the company‟s inventory, both in terms of the cost of the item and the need for the item in the manufacturing or sales process. Controlling this top 20 percent will control 80 percent of their inventory costs. “B” items are those of mid-range value and “C” items are cheap and rarely in demand. The retailer or manufacturer can now categorize all items in the inventory into one of these three classes and then monitor the stock according to value. "A" items would be counted and tracked regularly, while "B" and "C" items would be counted only monthly or quarterly.
Counting Current Stock All businesses must know what they have on hand and evaluate stock levels with respect to current and forecasted demands. You must know what you have in stock to ensure you can meet the demands of customers and production and to be sure you are ordering enough stock in the future. Counting is also important because it is the only way you will know if there is a problem with theft occurring at some point in the supply chain. When you become aware of such problems you can take steps to eliminate them.
Cyclical Counting Many companies prefer to count inventory on a cyclical basis to avoid the need for shutting down operations while stock is counted. This means that a particular section of the warehouse or plant is counted at particular times, rather than counting all inventory at once. In this way, the company takes a physical count of inventory, but never counts the entire inventory at once. While this method may be less accurate than counting the whole, it is much more cost effective.
Controlling Supply and Demand Whenever possible, obtain a commitment from a customer for a purchase. In this way, you ensure that the items you order will not take space in your inventory for long. When this is not possible, you may be able to share responsibility for the cost of carrying goods with the salesperson, to ensure that an order placed actually results in a sale. You can also keep a list of goods that can easily be sold to another party, should a customer cancel. Such goods can be ordered without prior approval. Approval procedures should be arranged around several factors. You should set minimum and maximum quantities which your buyers can order without prior approval. This ensures that you are maximizing any volume discounts available through your vendors and preventing over-ordering of stock. It is also important to require pre-approval on goods with a high carrying cost.
Keeping Accurate Records Any time items arrive at or leave a warehouse, accurate paperwork should be kept, itemizing the goods. When inventory arrives, this is when you will find breakage or loss on the goods you ordered. Inventory leaving your warehouse must be counted to prevent loss between the warehouse and the point of sale. Even samples should be recorded, making the salesperson responsible for the goods until they are returned to the storage facility. Records should be processed quickly, at least in the same day that the withdrawal of stock occurred.
Managing Employees Buyers are the employees who make stock purchases for your company. Reward systems should be set in place that encourage high levels of customer service and return on investment for the product lines the buyer manages. Warehouse employees should be educated on the costs of improper inventory management. Be sure they understand that the lower your profit margin, the more sales must be generated to make up for the lost goods. Incentive programs can help employees keep this in perspective. When they see a difference in their paychecks from poor inventory management, they are more likely to take precautions to prevent shrinkage. Each stock item in your warehouse or back room should have its own procedures for replenishing the supply. Find the best suppliers and storage location for each and record this information in official procedures that can easily be accessed by your employees.
Contd… Inventory management should be a part of your overall strategic business plan. As the business climate evolves towards a green economy, businesses are looking for ways to leverage this trend as part of the “big picture”. This can mean reevaluating your supply chain and choosing products that are environmentally sound. It can also mean putting in place recycling procedures for packaging or other materials. In this way, inventory management is more than a means to control costs; it becomes a way to promote your business.
Water Tank Analogy for Inventory Inventory Level Supply Rate Buffers Demand Inventory Level Rate from Supply Rate Demand Rate
Bullwhip effect Demand information is distorted as it moves away from the end-use customer. Higher safety stock inventories to are stored to compensate
Two Forms of Demand Dependent ◦ Demand for items used to produce final products ◦ Tires stored at a Goodyear plant are an example of a dependent demand item Independent ◦ Demand for items used by external customers ◦ Cars, appliances, computers, and houses are examples of independent demand inventory
Reasons To Hold Inventory Meet variations in customer demand: ◦ Meet unexpected demand ◦ Smooth seasonal or cyclical demand Pricing related: ◦ Temporary price discounts ◦ Hedge against price increases ◦ Take advantage of quantity discounts Process & supply surprises ◦ Internal – upsets in parts of or our own processes ◦ External – delays in incoming goods Transit
Reasons NOT To Hold Inventory Carrying cost ◦ Financially calculable Takes up valuable factory space ◦ Especially for in-process inventory Inventory covers up “problems” … ◦ That are best exposed and solvedDriver for increasing inventory turns (finished goods)and lean production/Just in time for work in process
To Expose Problems: Reduce Inventory Levels Bad Design Lengthy Poor Setups Quality Machine Inefficient Unreliable Breakdown Layout Supplier
Remove Sources of Problems and Repeat the ProcessPoor QualityLengthySetups Bad MachineDesign Inefficient Unreliable Breakdown Layout Supplier
Inventory Cost Structures Ordering (or setup) cost Carrying (or holding) cost: ◦ Cost of capital ◦ Cost of storage ◦ Cost of obsolescence, deterioration, and loss Stock out cost Item costs, shipping costs and other cost subject to volume discounts
Typical Inventory Carrying Costs Costs as % of Inventory Value Housing cost: ◦ Building rent or depreciation 6% ◦ Building operating cost (3% - 10%) ◦ Taxes on building ◦ Insurance Material handling costs: ◦ Equipment, lease, or depreciation 3% ◦ Power (1% - 4%) ◦ Equipment operating cost 3% Manpower cost from extra handling and supervision (3% - 5%) Investment costs: ◦ Borrowing costs 10% ◦ Taxes on inventory (6% - 24%) ◦ Insurance on inventory Pilferage, scrap, and obsolescence 5% (2% - 10%) Overall carrying cost (15% - 50%)
Inventory Management Systems Functions of Inventory Management – Track inventory – How much to order – When to order Prioritization Inventory Management Approach – EOQ – Continuous / Periodic
ABC Prioritization Based on “Pareto” concept (80/20 rule) and total usage in dollars of each item. Classification of items as A, B, or C often based on $ volume. Purpose: set priorities for management attention.
ABC Prioritization „A‟ items: 20% of SKUs, 80% of Value „B‟ items: 30 % of SKUs, 15% of Value „C‟ items: 50 % of SKUs, 5% of Value Three classes is arbitrary; could be any number. Percents are approximate. Danger: Money use may not reflect importance of any given SKU!
Annual Usage of Items by Dollar Value Percentage of Annual Usage in Total Dollar Item Units Unit Cost Dollar Usage Usage 1 5,000 $ 1.50 $ 7,500 2.9% 2 1,500 8.00 12,000 4.7% 3 10,000 10.50 105,000 41.2% 4 6,000 2.00 12,000 4.7% 5 7,500 0.50 3,750 1.5% 6 6,000 13.60 81,600 32.0% 7 5,000 0.75 3,750 1.5% 8 4,500 1.25 5,625 2.2% 9 7,000 2.50 17,500 6.9% 10 3,000 2.00 6,000 2.4% Total $ 254,725 100.0%
ABC Chart For Previous Slide 45.0% 120.0% 40.0% 100.0% Cumulative % Usage 35.0% A B C Percent Usage 30.0% 80.0% 25.0% 60.0% 20.0% 15.0% 40.0% 10.0% 20.0% 5.0% 0.0% 0.0% 3 6 9 2 4 1 10 8 5 7 Item No. Percentage of Total Dollar Usage Cumulative Percentage
ABC Classification Class A ◦ 20 % of Inventory ◦ 80 % of value Class B ◦ 30 % of Inventory ◦ 15 % of value Class C ◦ 50 % of Inventory ◦ 5 % of value
ABC Analysis Example 100 — +Class C +Class B 90 — Percentage of dollar value Class A 80 — 70 — 60 — 50 — 40 — 30 — 20 — 10 — 0— 10 20 30 40 50 60 70 80 90 100 Percentage of items
Inventory Management Approaches A-items – Track carefully (e.g. continuous review) – Sophisticated forecasting to assure correct levels C-items – Track less frequently (e.g. periodic review) – Accept risks of too much or too little (depending on the item)
Item Quality Quantity order CheckingA Costlier Less Regular system to see that there is no overstocking as well as that there is no danger of production being interrupted for unwanted material.B Less costlier Order may be on Position being viewed review basis. in each monthC Economical Larger Order in large quantity so that cost can be avoided
Economic Order Quantity (EOQ) Model Demand rate D is constant, recurring, and known Amount in inventory is known at all times Ordering (setup) cost S per order is fixed Lead time L is constant and known. Unit cost C is constant (no quantity discounts) Annual carrying cost is i time the average $ value of the inventory No stockout allowed. Material is ordered or produced in a lot or batch and the lot is received all at once
EOQ Lot Size Choice There is a trade-off between lot size and inventory level. ◦ Frequent orders (small lot size): higher ordering cost and lower holding cost. ◦ Fewer orders (large lot size): lower ordering cost and higher holding cost.
EOQ Inventory Order Cycle Demand rate Order qty, Q Inventory Level ave = Q/2Reorder point, R 0 Lead Lead Time time time Order Order Order Order Placed Received Placed Received As Q increases, average inventory level increases, but number of orders placed decreases
Answer to Inventory Management Questions for EOQModelKeeping track of inventory ◦ Implied that we track continuouslyHow much to order? ◦ Solve for when the derivative of total cost with respect to Q = 0: -SD/Q^2 + iC/2 = 0 ◦ Q = sqrt ( 2SD/iC)When to order? ◦ Order when inventory falls to the “Reorder Point-level” R so we will just sell the last item as the new order comes in: ◦ R = DL
Re-order Point ExampleDemand = 10,000 yds/ yearLead time = L = 10 daysWhen inventory falls to R, we order so as not to run out before thenew order comes in.R=?
Re-order Point ExampleDemand = 10,000 yds/yearDaily demand = 10,000 / 365 = 27.4 yds/dayLead time = L = 10 daysR = D*L = (27.4)(10) = 274 yds(usually can neglect issues of working days vs weekends, etc.) Don’t forget to convert to consistent time units!
EOQ SummaryHow much to order? ◦ Q = sqrt(2DS/iC)When to order? ◦ R = DL
Inventory Control Systems Continuous system (fixed-order- quantity) ◦ constant amount ordered when inventory declines to predetermined level Periodic system (fixed-time-period) ◦ order placed for variable amount after fixed passage of time
Quantity Discounts Model Price per unit decreases as order quantity increases Co D CcQ TC = + + PD Q 2 where P = per unit price of the item D = annual demand
Quantity Discounts Model QUANTITY PRICE Co = $2,500 1 - 49 $1,400 Cc = $190 per computer 50 - 89 1,100 D = 200 90+ 900 2CoD 2(2500)(200) Qopt = = = 72.5 PCs Cc 190 For Q = 72.5 CoD CcQopt TC = + 2 + PD = $233,784 Qopt For Q = 90 CcQ CoD TC = + 2 + PD = $194,105 Q
EOQ Exercise Now you do it See Excel Spreadsheet: Excel_Inv_Examples.xls, EOQ tab Compute the values of R and Q and compare to the simulation Next see what happens when you have volume discounts (EOQ w Discount Tab)
Safety Stocks Safety stock ◦ buffer added to on hand inventory during lead time Stockout ◦ an inventory shortage Service level ◦ probability that the inventory available during lead time will meet demand
Perpetual Inventory System It is a method of recording stores balances after every receipt and issue, to facilitate regular checking and obviate closing down for stock taking. -Wheldon
Factors which are helpful to make system successful Stores ledger, stores control, cards or bin cards are properly maintained ; Quantity balance store shown in the store ledger; stock control and bin cards are reconciled; Exploring the cause of discrepancies if any physical balances and book balances.
Daily Readings Product Month Year Pump 1 Pump 2 Pump 3 Pump 4 Total Tank 1 Tank 2 Total Meter Dip Inventroy Water Dip Dip Inventroy Water Dip PhysicalDay Readings Sales Readings Sales Readings Sales Readings Sales Sales cm. litres cm. cm. litres cm. Inventory12345678910111213141516171819202122232425262728293031
Monthly Summary Product Product Product Storage Capacity Storage Capacity Storage Capacity Total Variation Total Variation Total Variation % Loss % Loss % LossMonth Sales for Month Sales for Month Sales for Month
Inventory Turnover MethodIt means how many times a company‟s inventory is sold and replaced (finished product) Generally calculated as: Sales/ Inventory However it may also be calculated as: Cost of goods sold/ Average Inventory
Reduce your inventory NOW!!! Things you can do to free up some cash right now: Adjust safety stock Reduce safety lead time Cut PO quantities in half and double the number of receipts Implement supplier kanban (its not that hard) Rebalance your A, B, C items and cut back on the C‟s Put Purchasing on a strict diet – limit monthly spend to 1/10 of the annual plan Revise the annual plan to reflect current reality Suppliers are hungry, so lock in shorter lead times Liquidate your slow moving stock: have a Sale Reduce production lot sizes